International financial management 8th edition eun test bank

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International Financial Management, 8e (Eun) Chapter 9 Management of Economic Exposure 1) Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange rate A) can have significant economic consequences for U.S. firms.

B) can have significant economic consequences for Japanese firms.

C) can have significant economic consequences for both U.S. and Japanese firms.

D) none of the options Answer: C Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation 2) Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange rate A) will tend to weaken the competitive position of import-competing U.S. car makers.

B) will tend to strengthen the competitive position of import-competing U.S. car makers.

C) will tend to strengthen the competitive position of Japanese car makers at the expense of U.S. makers.

D) none of the options Answer: B Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation 3) The link between a firm's future operating cash flows and exchange rate fluctuations is A) asset exposure.

B) operating exposure.

C) asset exposure and operating exposure.

D) none of the options Answer: B Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation 4) When the Mexican peso collapsed in 1994, declining by 37 percent, A) U.S. firms that exported to Mexico and priced in peso were adversely affected.

B) U.S. firms that exported to Mexico and priced in dollars were adversely affected.

C) U.S. firms were unaffected by the peso collapse, since Mexico is such a small market.

D) U.S. firms that exported to Mexico and priced in peso were adversely affected, and U.S. firms that exported to Mexico and priced in dollars were adversely affected.

Answer: D Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation 1 Copyright © 2018 McGraw-Hill

5) When exchange rates change, A) U.S. firms that produce domestically and sell only to domestic customers will be unaffected.

B) U.S. firms that produce domestically and sell only to domestic customers can be affected if they compete against imports.

C) U.S. firms that produce domestically and sell only to domestic customers will be affected, but only if they borrow in foreign currency to finance their domestic operations.

D) U.S. firms that produce domestically and sell only to domestic customers will be unaffected, and U.S. firms that produce domestically and sell only to domestic customers can be affected if they compete against imports.

Answer: B Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation 6) When exchange rates change, A) this can alter the operating cash flow of a domestic firm.

B) this can alter the competitive position of a domestic firm.

C) this can alter the home currency values of a multinational firm's assets and liabilities.

D) all of the options Answer: D Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation 7) Two studies found a link between exchange rates and the stock prices of U.S. firms; A) this suggests that exchange rate changes can systematically affect the value of the firm by influencing its operating cash flows.

B) this suggests that exchange rate changes can systematically affect the value of the firm by influencing the domestic currency values of its assets and liabilities.

C) this suggests that exchange rate changes can systematically affect the value of the firm by influencing its operating cash flows, as well influencing the domestic currency values of its assets and liabilities.

D) none of the options Answer: C Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation 8) It is conventional to classify foreign currency exposures into the following types: A) economic exposure, transaction exposure, and translation exposure.

B) economic exposure, noneconomic exposure, and political exposure.

C) national exposure, international exposure, and trade exposure.

D) conversion exposure, and exchange exposure.

Answer: A Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation 2 Copyright © 2018 McGraw-Hill

9) Exposure to currency risk can be measured by the sensitivities of A) the future home currency values of the firm's assets and liabilities.

B) the firm's operating cash flows to random changes in exchange rates.

C) the future home currency values of the firm's assets and liabilities, as well as the firm's operating cash flows to random changes in exchange rates.

D) none of the options Answer: C Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation 10) Operating exposure measures A) the extent to which the foreign currency value of the firm's assets is affected by unanticipated changes in exchange rates.

B) the extent to which the firm's operating cash flows will be affected by unexpected changes in exchange rates.

C) the effect of changes in exchange rates will have on the consolidated financial reports of a MNC. D) the effect of unanticipated changes in exchange rates on the dollar value of contractual obligations denominated in a foreign currency.

Answer: B Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation 11) Economic exposure refers to A) the sensitivity of realized domestic currency values of the firm's contractual cash flows denominated in foreign currencies to unexpected exchange rate changes.

B) the extent to which the value of the firm would be affected by unanticipated changes in exchange rate.

C) the potential that the firm's consolidated financial statement can be affected by changes in exchange rates.

D) ex post and ex ante currency exposures.

Answer: B Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation

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12) Currency risk A) is the same as currency exposure.

B) represents random changes in exchange rates.

C) measure "what the firm has at risk."

D) is the same as currency exposure and represents random changes in exchange rates.

Answer: B Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation 13) Suppose a U.S.-based MNC maintains a vacation home for employees in the British countryside and the local price of this property is always moving together with the pound price of the U.S. dollar. As a result, A) whenever the pound depreciates against the dollar, the local currency price of this property goes up by the same proportion.

B) the firm is not exposed to currency risk even if the pound–dollar exchange rate fluctuates randomly.

C) whenever the pound depreciates against the dollar, the local currency price of this property goes up by the same proportion. Additionally, the firm is not exposed to currency risk even if the pound–dollar exchange rate fluctuates randomly.

D) none of the options Answer: C Topic: How to Measure Economic Exposure 14) The exposure coefficient in the regression P = a + b × S + e is given by A) b = B) P = a + b × S + e C) b = D) none of the options Answer: A Topic: How to Measure Economic Exposure

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15) The exposure coefficient b =

in the regression P = a + b × S + e is

A) a measure of how a change in the exchange rate affects the dollar value of a firm's assets.

B) a value of zero if the value of the firm's assets is perfectly correlated with changes in the exchange rate.

C) a measure of how a change in the exchange rate affects the dollar value of a firm's assets, and has a value of zero if the value of the firm's assets is perfectly correlated with changes in the exchange rate.

D) none of the options Answer: A Topic: How to Measure Economic Exposure 16) The exposure coefficient b =

in the regression P = a + b × S + e informs

A) how much of a foreign currency to sell forward.

B) the part of the variability of the dollar value of the asset that is related to random changes in the exchange rate.

C) captures the residual part of the dollar value variability that is independent of exchange rate movements.

D) how many call options to write.

Answer: A Topic: How to Measure Economic Exposure 17) Before you can use the hedging strategies such as a forward market hedge, options market hedge, and so on, you should consider running a regression of the form P = a + b × S + e . When reviewing the output, you should initially focus on A) the intercept a.

B) the slope coefficient b.

C) mean square error, MSE. D) R2.

Answer: B Topic: How to Measure Economic Exposure

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18) The link between the home currency value of a firm's assets and liabilities and exchange rate fluctuations is A) asset exposure.

B) operating exposure.

C) asset exposure and operating exposure.

D) none of the options Answer: A Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation 19) A purely domestic firm that sources and sells only domestically, A) faces exchange rate risk to the extent that it has international competitors in the domestic market.

B) faces no exchange rate risk.

C) should never hedge since this could actually increase its currency exposure.

D) faces no exchange rate risk and should never hedge since this could actually increase its currency exposure.

Answer: A Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation 20) In recent years, the U.S. dollar has depreciated substantially against most major currencies of the world, especially against the euro.

A) The stronger euro has made many European products more expensive in dollar terms, hurting sales of these products in the United States.

B) The stronger euro has made many American products less expensive in euro terms, boosting sales of U.S. products in Europe.

C) The stronger euro has made many European products more expensive in dollar terms, hurting sales of these products in the United States. Additionally, the stronger euro has made many American products less expensive in euro terms, boosting sales of U.S. products in Europe.

D) none of the options Answer: C Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation

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21) In recent years, A) the U.S. dollar has appreciated substantially against most major currencies of the world, especially against the euro.

B) the U.S. dollar has depreciated substantially against most major currencies of the world, especially against the euro.

C) the U.S. dollar has maintained its value against most major currencies of the world, especially against the euro.

D) none of the options Answer: B Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation 22) From the perspective of the U.S. firm that owns an asset in Britain, the exposure that can be measured by the coefficient b in regressing the dollar value P of the British asset on the dollar– pound exchange rate S using regression equation P = a + b × S + e is A) asset exposure.

B) operating exposure.

C) accounting exposure.

D) none of the options Answer: A Topic: How to Measure Economic Exposure 23) On the basis of regression equation P = a + b × S + e, we can decompose the variability of the dollar value of the asset, VAR(P), into two separate components: A) Cov(P,S) = b2 × VAR(P) + VAR(S) B) VAR(P) = b2 × VAR(S) + VAR(e) C) Cov(P,S) = b2 × Cov(S,P) + Cov(S,e) D) VAR(P) = b2 × VAR(S) Answer: B Topic: How to Measure Economic Exposure

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24) On the basis of regression equation P = a + b × S + e, we can decompose the variability of the dollar value of the asset, VAR(P), into two separate components: VAR(P) = b2 × VAR(S) + VAR(e). The first term in the right-hand side of the equation, b2 × VAR(S) represents A) the part of the variability of the dollar value of the asset that is related to random changes in the exchange rate.

B) the residual part of the dollar value variability that is independent of exchange rate movements.

C) the part of the variability of the dollar value of the asset that is related to random changes in the exchange rate, as well as the residual part of the dollar value variability that is independent of exchange rate movements.

D) none of the options Answer: A Topic: How to Measure Economic Exposure 25) On the basis of regression equation P = a + b × S + e, we can decompose the variability of the dollar value of the asset, VAR(P), into two separate components: VAR(P) = b2 × VAR(S) + VAR(e). The second term in the right-hand side of the equation, VAR(e) represents A) the part of the variability of the dollar value of the asset that is related to random changes in the exchange rate.

B) the residual part of the dollar value variability that is independent of exchange rate movements.

C) the part of the variability of the dollar value of the asset that is related to random changes in the exchange rate, as well as the residual part of the dollar value variability that is independent of exchange rate movements.

D) none of the options Answer: B Topic: How to Measure Economic Exposure 26) What does it mean to have redenominated an asset in terms of the dollar?

A) You have undertaken a hedging strategy that gives the asset a constant dollar value.

B) Multiply the foreign currency value of the asset by the spot exchange rate.

C) You have undertaken accounting changes to eliminate translation exposure.

D) none of the options Answer: A Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation

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27) A firm with a highly elastic demand for its products A) will be unable to pass increased costs following unfavorable changes in the exchange rate without significantly lowering the quantity sold.

B) will be able to raise prices following unfavorable changes in the exchange rate without significantly lowering the quantity sold.

C) can easily pass increased costs on to consumers.

D) will sell about the same amount of product regardless of price.

Answer: A Topic: How to Measure Economic Exposure Accessibility: Keyboard Navigation 28) Operating exposure can be defined as A) the link between the future home currency values of the firm's assets and liabilities and exchange rate fluctuations.

B) the extent to which the firm's operating cash flows would be affected by random changes in exchange rates.

C) the sensitivity of realized domestic currency values of the firm's contractual cash flows denominated in foreign currencies to unexpected exchange rate changes.

D) the potential that the firm's consolidated financial statement can be affected by changes in exchange rates.

Answer: B Topic: Operating Exposure: Definition Accessibility: Keyboard Navigation 29) The extent to which the firm's operating cash flows would be affected by random changes in exchange rates is called A) asset exposure.

B) operating exposure.

C) asset exposure or operating exposure.

D) none of the options Answer: B Topic: Operating Exposure: Definition Accessibility: Keyboard Navigation

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30) The variability of the dollar value of an asset (invested overseas) depends on A) the variability of the dollar value of the asset that is related to random changes in the exchange rate.

B) the dollar value variability that is independent of exchange rate movements.

C) the variability of the dollar value of the asset that is related to random changes in the exchange rate, as well as the dollar value variability that is independent of exchange rate movements.

D) none of the options Answer: C Topic: Operating Exposure: Definition Accessibility: Keyboard Navigation 31) Consider a U.S. MNC who owns a foreign asset. If the foreign currency value of the asset is inversely related to changes in the dollar–foreign currency exchange rate, A) the company has a built-in hedge.

B) the dollar value variability that is independent of exchange rate movements.

C) the company has a built-in hedge and the dollar value variability that is independent of exchange rate movements.

D) none of the options Answer: C Topic: Operating Exposure: Definition 32) With regard to operational hedging versus financial hedging, A) operational hedging provides a more stable long-term approach than does financial hedging.

B) financial hedging, when instituted on a rollover basis, is a superior long-term approach to operational hedging.

C) since they both have the same goal, stabilizing the firm's cash flows in domestic currency, they are fungible in use.

D) none of the options Answer: A Topic: Operating Exposure: Definition Accessibility: Keyboard Navigation

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33) Which of the following are identified by your text as a strategy for managing operating exposure? (i) Selecting low-cost production sites (ii) Flexible sourcing policy (iii) Diversification of the market (iv) Product differentiation and R&D efforts (v) Financial Hedging A) (i), (iii), and (v) only B) (ii) and (iv) only C) (i), (iv), and (v) only D) all of the options Answer: D Topic: Operating Exposure: Definition 34) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.20/£ £ 2,000 $ 4,400

State 2 50% $ 2.00/£ £ 2,500 $ 5,000

where, P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset The expected value of the investment in U.S. dollars is A) $4,950.

B) $3,700.

C) $2,112.50.

D) none of the options Answer: A Explanation: $4,400 (0.25) + $5,000 (0.5) + $5,400 (0.25) = $4,950 Topic: Operating Exposure: Definition Accessibility: Keyboard Navigation

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State 3 25% $ 1.80/£ £ 3,000 $ 5,400

35) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.20/£ £ 2,000 $ 4,400

State 2 50% $ 2.00/£ £ 2,500 $ 5,000

State 3 25% $ 1.80/£ £ 3,000 $ 5,400

where, P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset The variance of the exchange rate is: A) 0.0200 B) 0.10 C) 0.002 D) none of the options Answer: A Explanation: The mean is 2 = ($2.2 + $2 + $1.8) / 3; [0.25 (2.2 − 2)2] + [0.5 (2 - 2)2] + [0.25 (1.8 − 2)2] = 0.01 + 0 + 0.01 = 0.02 Topic: Operating Exposure: Definition

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36) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.20/£ £ 2,000 $ 4,400

State 2 50% $ 2.00/£ £ 2,500 $ 5,000

State 3 25% $ 1.80/£ £ 3,000 $ 5,400

P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset The "exposure" (i.e. the regression coefficient beta) is Hint: Calculate the expression

.

A) −25,000 B) 2,500 C) −2,500 D) none of the options Answer: C Explanation: First, find the variance. The mean is 2 = ($2.2 + $2 + $1.8) / 3; [0.25 (2.2 − 2)2] + [0.5 (2 − 2)2] + [0.25 (1.8 − 2)2] = 0.01 + 0 + 0.01 = 0.02 Next, find the covariance, where the mean = $4,933.33 = ($4,400 + $5,000 + $5,400) / 3. Solve, 0.25 [($4,400 −$4,933.33) × (2.2 − 2)] + 0.5 [($5,000 − $4,933.33) × (2 − 2)] + 0.25 [($5,000 − $4,933.33) × (1.8 − 2)] = −26.6665 + 0 − 23.3335 = −50. Exposure = −50 / 0.02 = − $2,500.

Topic: Operating Exposure: Definition

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37) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.20/£ £ 2,000 $ 4,400

State 2 50% $ 2.00/£ £ 2,500 $ 5,000

State 3 25% $ 1.80/£ £ 3,000 $ 5,400

where, P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset Which of the following conclusions are correct?

A) Most of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b2[Var(S)] and VAR(e) are 236,717 ($)2 and 493,751 ($)2 respectively.

B) Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange risk because b2[Var(S)] and VAR(e) are 236,717 ($)2 and 493,751 ($)2 respectively.

C) Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange risk because b2[Var(S)] and VAR(e) are 125,000 ($)2 and −127,500 ($)2 respectively.

D) Most of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b2[Var(S)] and VAR(e) are 125,000 ($)2 and −127,500 ($)2 respectively.

Answer: D Topic: Operating Exposure: Definition

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38) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.20/£ £ 2,000 $ 4,400

State 2 50% $ 2.00/£ £ 2,500 $ 5,000

State 3 25% $ 1.80/£ £ 3,000 $ 5,400

where, P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset Which of the following would be an effective hedge?

A) Sell £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.

B) Buy £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.

C) Sell £25,000 forward at the 1-year forward rate, F1($/£), that prevails at time zero.

D) none of the options Answer: B Topic: Operating Exposure: Definition 39) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.20/£ £ 3,000 $ 6,600

State 2 50% $ 2.00/£ £ 2,500 $ 5,000

where, P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset The expected value of the investment in U.S. dollars is A) $5,050 B) $3,700 C) $2,112.50 D) none of the options Answer: A Explanation: $6,600 (0.25) + $5,000 (0.5) + $3,600 (0.25) = $5,050 Topic: Operating Exposure: Definition Accessibility: Keyboard Navigation

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State 3 25% $ 1.80/£ £ 2,000 $ 3,600

40) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.20/£ £ 3,000 $ 6,600

State 2 50% $ 2.00/£ £ 2,500 $ 5,000

State 3 25% $ 1.80/£ £ 2,000 $ 3,600

where, P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset The variance of the exchange rate is A) 0.0200 B) 0.10 C) 0.002 D) none of the options Answer: A Explanation: The mean is 2 = ($2.2 + $2 + $1.8) / 3; [0.25 (2.2 − 2)2] + [0.5 (2 − 2)2] + [0.25 (1.8 − 2)2] = 0.01 + 0 + 0.01 = 0.02 Topic: Operating Exposure: Definition

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41) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.20/£ £ 3,000 $ 6,600

State 2 50% $ 2.00/£ £ 2,500 $ 5,000

State 3 25% $ 1.80/£ £ 2,000 $ 3,600

where, P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset The "exposure" (i.e. the regression coefficient beta) is Hint: Calculate the expression

.

A) 7,500 B) 2,500 C) −2,500 D) none of the options Answer: A Explanation: First, find the variance. The mean is 2 = ($2.2 + $2 + $1.8) / 3; [0.25 (2.2 − 2)2] + [0.5 (2 − 2)2] + [0.25 (1.8 − 2)2] = 0.01 + 0 + 0.01 = 0.02 Next, find the covariance, where the mean = $5,066.67 = ($6,600 + $5,000 + $3,600) / 3. Solve, 0.25 [($6,600 − $5,066.67) × (2.2 − 2)] + 0.5 [($5,000 − $5,066.67) × (2 − 2)] + 0.25 [($3,600 − $5,066.67) × (1.8 − 2)] = 76.6665 + 0 + 73.3335 = 150. Exposure = 150 / 0.02 = $7,500.

Topic: Operating Exposure: Definition

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42) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.20/£ £ 3,000 $ 6,600

State 2 50% $ 2.00/£ £ 2,500 $ 5,000

State 3 25% $ 1.80/£ £ 2,000 $ 3,600

where, P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset Which of the following conclusions are correct?

A) Most of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b2[Var(S)] and VAR(e) are 1,125,000 ($)2 and 2,500 ($)2 respectively.

B) Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange risk because b2[Var(S)] and VAR(e) are 236,717 ($)2 and 493,751 ($)2 respectively.

C) Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange risk because b2[Var(S)] and VAR(e) are 125,000 ($)2 and −127,500 ($)2 respectively.

D) Most of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b2[Var(S)] and VAR(e) are 125,000 ($)2 and −127,500 ($)2 respectively.

Answer: A Topic: Operating Exposure: Definition

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43) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.20/£ £ 3,000 $ 6,600

State 2 50% $ 2.00/£ £ 2,500 $ 5,000

State 3 25% $ 1.80/£ £ 2,000 $ 3,600

where, P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset Which of the following would be an effective hedge?

A) Sell £7,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.

B) Buy £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.

C) Sell £25,000 forward at the 1-year forward rate, F1($/£), that prevails at time zero.

D) none of the options Answer: A Topic: Operating Exposure: Definition 44) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.50/£ £ 1,800 $ 4,500

State 2 50% $ 2.00/£ £ 2,250 $ 4,500

where, P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset The expected value of the investment in U.S. dollars is: A) $5,050 B) $4,500 C) $2,112.50 D) none of the options Answer: B Explanation: $4,500 (0.25) + $4,500 (0.5) + $4,500 (0.25) = $4,500 Topic: Operating Exposure: Definition Accessibility: Keyboard Navigation

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State 3 25% $ 1.60/£ £ 2,812.50 $ 4,500

45) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.50/£ £ 1,800 $ 4,500

State 2 50% $ 2.00/£ £ 2,250 $ 4,500

State 3 25% $ 1.60/£ £ 2,812.50 $ 4,500

where, P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset The variance of the exchange rate is A) 0.0200 B) 0.1019 C) 0.0020 D) none of the options Answer: B Explanation: The mean is 2.03 = ($2.5 + $2 + $1.6) / 3; [0.25 (2.5 − 2.03)2] + [0.5 (2 − 2.03)2] + [0.25 (1.6 − 2.03)2] = 0.055225 + 0.00045 + 0.046225 = 0.1019 Topic: Operating Exposure: Definition

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46) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.50/£ £ 1,800 $ 4,500

State 2 50% $ 2.00/£ £ 2,250 $ 4,500

State 3 25% $ 1.60/£ £ 2,812.50 $ 4,500

where, P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset The "exposure" (i.e. the regression coefficient beta) is Hint: Calculate the expression

.

A) 7,500 B) 2,500 C) −2,500 D) none of the options Answer: D Explanation: First, find the variance. The mean is 2.03 = ($2.5 + $2 + $1.6) / 3; [0.25 (2.5 − 2.03)2] + [0.5 (2 − 2.03)2] + [0.25 (1.6 − 2.03)2] = 0.055225 + 0.00045 + 0.046225 = 0.1019.

Next, find the covariance, where the mean = $4,500 = ($4,500 + $4,500 + $4,500) / 3. Solve, 0.25 [($4,500 − $4,500) × (2.5 − 2.03)] + 0.5 [($4,500 − $4,500) × (2 − 2.03)] + 0.25 [($4,500 − $4,500) × (1.6 − 2.03)] = 0. Exposure = 0 / 0.1019 = $0.

Topic: Operating Exposure: Definition

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47) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.50/£ £ 1,800 $ 4,500

State 2 50% $ 2.00/£ £ 2,250 $ 4,500

State 3 25% $ 1.60/£ £ 2,812.50 $ 4,500

where, P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset Which of the following conclusions are correct?

A) Most of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b2[VAR(S)] and VAR(e) are 0 ($)2 and 0 ($)2 respectively.

B) None of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b2[VAR(S)] and VAR(e) are 0 ($)2 and 0 ($)2 respectively.

C) Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange risk because b2[VAR(S)] and VAR(e) are 125,000 ($)2 and −127,500 ($)2 respectively.

D) Most of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b2[VAR(S)] and VAR(e) are 125,000 ($)2 and −127,500 ($)2 respectively.

Answer: B Topic: Operating Exposure: Definition

22 Copyright © 2018 McGraw-Hill

48) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.50/£ £ 1,800 $ 4,500

State 2 50% $ 2.00/£ £ 2,250 $ 4,500

State 3 25% $ 1.60/£ £ 2,812.50 $ 4,500

where, P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset Which of the following would be an effective hedge?

A) Sell £2,278.13 forward at the 1-year forward rate, F1($/£), that prevails at time zero.

B) Buy £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.

C) Sell £25,000 forward at the 1-year forward rate, F1($/£), that prevails at time zero.

D) none of the options Answer: D Topic: Operating Exposure: Definition 49) A U.S. firm holds an asset in Israel and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 0.30/IS IS 2,000 $ 600

State 2 50% $ 0.20/IS IS 5,000 $ 1,000

where, P* = Israeli shekel (IS) price of the asset held by the U.S. firm P = Dollar price of the same asset The expected value of the investment in U.S. dollars is: A) $2,083.33 B) $762.50 C) $6,250.00 D) $6,562.50 Answer: B Explanation: $600 (0.25) + $1,000 (0.5) + $450 (0.25) = $762.50 Topic: Operating Exposure: Definition

23 Copyright © 2018 McGraw-Hill

State 3 25% $ 0.15/IS IS 3,000 $ 4,50

50) A U.S. firm holds an asset in Israel and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 0.30/IS IS 2,000 $ 600

State 2 50% $ 0.20/IS IS 5,000 $ 1,000

State 3 25% $ 0.15/IS IS 3,000 $ 4,50

where, P* = Israeli shekel (IS) price of the asset held by the U.S. firm P = Dollar price of the same asset The variance of the exchange rate is: A) 0.001901 B) 0.002969 C) 0.0039 D) 0.0049 Answer: B Explanation: $0.2125 = 0.25 ($0.30) + 0.50 ($020) + 0.25 ($0.15); [0.25 (0.30 − 0.2125)2] + [0.5 (0.20 − 0.2125)2] + [0.25 (0.15 − 0.2125)2] = 0.001914 + 0.000078 + 0.000976 = 0.002969 Topic: Operating Exposure: Definition

24 Copyright © 2018 McGraw-Hill

51) A U.S. firm holds an asset in Israel and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 0.30/IS IS 2,000 $ 600

State 2 50% $ 0.20/IS IS 5,000 $ 1,000

where, P* = Israeli shekel (IS) price of the asset held by the U.S. firm P = Dollar price of the same asset The "exposure" (i.e., the regression coefficient beta) is Hint: Calculate the expression

.

A) −52.6316 B) 1,289.80 C) 12,898.00 D) none of the options Answer: A Topic: Operating Exposure: Definition

25 Copyright © 2018 McGraw-Hill

State 3 25% $ 0.15/IS IS 3,000 $ 4,50

52) A U.S. firm holds an asset in Israel and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 0.30/IS IS 2,000 $ 600

State 2 50% $ 0.20/IS IS 5,000 $ 1,000

State 3 25% $ 0.15/IS IS 3,000 $ 4,50

where, P* = Israeli shekel (IS) price of the asset held by the U.S. firm P = Dollar price of the same asset Which of the following conclusions are correct?

A) Most of the volatility of the dollar value of the Israeli asset can be removed by hedging exchange risk because b2[Var(S)] and VAR(e) are 236,717 ($)2 and 493,751 ($)2 respectively.

B) Most of the volatility of the dollar value of the Israeli asset cannot be removed by hedging exchange risk because b2[Var(S)] and VAR(e) are 236,717 ($)2 and 493,751 ($)2 respectively.

C) Most of the volatility of the dollar value of the Israeli asset cannot be removed by hedging exchange risk because b2[Var(S)] and VAR(e) are 8.22 ($)2 and 59,211 ($)2, respectively.

D) Most of the volatility of the dollar value of the Israeli asset can be removed by hedging exchange risk because b2[Var(S)] and VAR(e) are 8.22 ($)2 and 59,211 ($)2 respectively.

Answer: C Topic: Operating Exposure: Definition

26 Copyright © 2018 McGraw-Hill

53) A U.S. firm holds an asset in Israel and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 0.30/IS IS 2,000 $ 600

State 2 50% $ 0.20/IS IS 5,000 $ 1,000

State 3 25% $ 0.15/IS IS 3,000 $ 4,50

where, P* = Israeli shekel (IS) price of the asset held by the U.S. firm P = Dollar price of the same asset Which of the following would be an effective hedge?

A) Sell 53 Israeli shekels forward at the 1-year forward rate, F1($/IS), that prevails at time zero.

B) Buy 53 Israeli shekels forward at the 1-year forward rate, F1($/IS), that prevails at time zero.

C) Sell 12,898 Israeli shekels forward at the 1-year forward rate, F1($/IS), that prevails at time zero.

D) none of the options Answer: B Topic: Operating Exposure: Definition Accessibility: Keyboard Navigation

27 Copyright © 2018 McGraw-Hill

54) Find an effective hedge financial hedge if a U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.20/£ £ 3,000 $ 6,600

State 2 50% $ 2.00/£ £ 2,500 $ 5,000

State 3 25% $ 1.80/£ £ 2,000 $ 3,600

P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset The CFO runs a regression of the form P = a + b × S + e The regression coefficient beta is calculated as b = Where Cov(P,S) = 0.25 × ($6,600 - $5,050) × ($2.20 - $2.00) + 0.50 × ($5,000 - $5,050) × ($2.00 - $2.00) + 0.25 × ($3,600 - $5,050) × ($1.80 - $2.00) Cov(P,S) = 77.50 + 0 + 72.50 Cov(P,S) = 150 b=

= 7,500

The variance of the exchange rate is calculated as E(S) = 0.25 × $2.20 + 0.50 × $2.00 + 0.25 × $1.80 = $.55 + $1 + $.45 = $2.00 VAR(S) = 0.25 = 0.01 + 0 + 0.01 = 0.02

+ 0.50

+ 0.25

The expected value of the investment in U.S. dollars is: E[P] = 0.25 × $6,600 + 0.50 × $5,000 + 0.25 × $3,600 = $5,050 Which of the following is the most effective hedge financial hedge?

A) Sell £7,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.

B) Buy £7,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.

C) Sell £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero.

D) 0.25 × £3,000 + 0.50 × £2,500 + 0.25 × £2,000 = £2,500 Answer: A Topic: Operating Exposure: Definition 28 Copyright © 2018 McGraw-Hill

55) Find an effective hedge financial hedge if a U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P* P

State 1 25% $ 2.20/£ £ 3,000 $ 6,600

State 2 50% $ 2.00/£ £ 2,500 $ 5,000

State 3 25% $ 1.80/£ £ 2,000 $ 3,600

P* = Pound sterling price of the asset held by the U.S. firm P = Dollar price of the same asset The CFO runs a regression of the form P = a + b × S + e The regression coefficient beta is calculated as b = Where Cov(P,S) = 0.25 × ($6,600 - $5,050) × ($2.20 - $2.00) + 0.50 × ($5,000 - $5,050) × ($2.00 - $2.00) + 0.25 × ($3,600 - $5,050) × ($1.80 - $2.00) Cov(P,S) = 77.50 + 0 + 72.50 Cov(P,S) = 150 b=

= 7,500

The variance of the exchange rate is calculated as E(S) = 0.25 × $2.20 + 0.50 × $2.00 + 0.25 × $1.80 = $.55 + $1 + $.45 = $2.00 VAR(S) = 0.25 = 0.01 + 0 + 0.01 = 0.02

+ 0.50

+ 0.25

The expected value of the investment in U.S. dollars is: E[P] = 0.25 × $6,600 + 0.50 × $5,000 + 0.25 × $3,600 = $5,050 Suppose that you implement your hedge at F1($/£) = $2/£. Your cash flows in state 1, 2, and 3 respectively will be A) $5,100, $5,000, $5,100.

B) $5,100, $5,100, $5,100.

C) $5,000, $5,000, $5,000.

D) none of the options Answer: A Topic: Operating Exposure: Definition 29 Copyright © 2018 McGraw-Hill

56) A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability Spot rate P*

State 1 25% $ 2.50/£ £ 1,800

State 2 50% $ 2.00/£ £ 2,250

State 3 25% $ 1.60/£ £ 2,812.50

Where P* = Pound sterling price of the asset held by the U.S. firm The CFO decides to hedge his exposure by selling forward the expected value of the pound denominated cash flow at F1($/£) = $2/£. As a result, A) the firm's exposure to the exchange rate is made worse.

B) he has a nearly perfect hedge.

C) he has a perfect hedge.

D) none of the options Answer: A Topic: Operating Exposure: Definition 57) A U.S. firm holds an asset in Italy and faces the following scenario:

Probability Spot rate P*

State 1 30% $ 2.50 € 1,350.00

State 2 40% $ 1.50 € 2,250.00

State 3 30% $ 0.90 € 3,750.00

Where P* = Euro price of the asset held by the U.S. firm The CFO decides to hedge his exposure by selling forward the expected value of the euro denominated cash flow at F1($/£) = $1.50/€. As a result, A) the firm's exposure to the exchange rate is made worse.

B) he has a nearly perfect hedge.

C) he has a perfect hedge.

D) none of the options Answer: A Topic: Operating Exposure: Definition

30 Copyright © 2018 McGraw-Hill

58) Suppose a U.S. firm has an asset in Britain whose local currency price is random. For simplicity, suppose there are only three states of the world and each state is equally likely to occur.

The future local currency price of this British asset (P*) as well as the future exchange rate (S) will be determined, depending on the realized state of the world.

State 1

P* £ 980

S $ 1.40/£

S × P* $ 1,372

2

Probability 1/3 1/3

£ 1,000

$ 1.50/£

$ 1,500

3

1/3

£ 1,070

$ 1.60/£

$ 1,712

Which of the following statements is most correct?

A) The firm faces no exchange rate risk since the local currency price of the asset and the exchange rate are negatively correlated.

B) The firm faces substantial exchange rate risk since the local currency price of the asset and the exchange rate are positively correlated.

C) The firm's exchange rate exposure can be completely hedged with derivatives written on the British pound.

D) Since randomness is involved, no hedging is possible.

Answer: B Topic: Operating Exposure: Definition 59) Suppose a U.S. firm has an asset in Britain whose local currency price is random. For simplicity, suppose there are only three states of the world and each state is equally likely to occur.

The future local currency price of this British asset (P*) as well as the future exchange rate (S) will be determined, depending on the realized state of the world.

State 1

P* £ 1,000

S $ 1.40/£

S × P* $ 1,400

2

Probability 1/3 1/3

£ 1,000

$ 1.50/£

$ 1,500

3

1/3

£ 1,000

$ 1.60/£

$ 1,600

Which of the following statements is most correct?

A) The firm faces no exchange rate risk since the local currency price of the asset and the exchange rate are negatively correlated.

B) The firm faces substantial exchange rate risk since the local currency price of the asset and the exchange rate are positively correlated.

C) The firm's exchange rate exposure can be completely hedged with derivatives written on the British pound.

D) Since randomness is involved, no hedging is possible.

Answer: C Topic: Operating Exposure: Definition 31 Copyright © 2018 McGraw-Hill

60) Suppose a U.S. firm has an asset in Britain whose local currency price is random. For simplicity, suppose there are only three states of the world and each state is equally likely to occur.

The future local currency price of this British asset (P*) as well as the future exchange rate (S) will be determined, depending on the realized state of the world.

State 1 2

Probability 1/3 1/3

3

1/3

P* £ 1,000

S $ 1.40/£

S × P* $ 1,400

£

933

$ 1.50/£

$ 1,400

£

875

$ 1.60/£

$ 1,400

Which of the following statements is most correct?

A) The firm faces no exchange rate risk since the local currency price of the asset and the exchange rate are negatively correlated.

B) The firm faces substantial exchange rate risk since the local currency price of the asset and the exchange rate are positively correlated.

C) The firm's exchange rate exposure can be completely hedged with derivatives written on the British pound.

D) Since randomness is involved, no hedging is possible.

Answer: A Topic: Operating Exposure: Definition 61) Suppose a U.S. firm has an asset in Italy whose local currency price is random. For simplicity, suppose there are only three states of the world and each state is equally likely to occur. The future local currency price of this asset (P*) as well as the future exchange rate (S) will be determined, depending on the realized state of the world.

State 1 2

Probability 1/3 1/3

3

1/3

P* € 1,000

S $ 1.40/£

S × P* $ 1,400

€

933

$ 1.50/£

$ 1,400

€

875

$ 1.60/£

$ 1,400

Assume that you choose to "hedge" this asset by selling forward the expected value of the euro denominated cash flow at F1($/£) = $1.50/€. Calculate your cash flows in each of the possible states.

A) $1,400, $1,400, $1,400 B) $1,496.6, $1,400, $1,306.40 C) $1,404, $1,404. $1,404 D) none of the options Answer: A Topic: Operating Exposure: Definition

32 Copyright © 2018 McGraw-Hill

62) Consider a U.S.-based MNC with a wholly-owned Italian subsidiary. Following a depreciation of the dollar against the euro, which of the following conclusions are correct?

A) The cash flow in euro could be altered due an alteration in the firm's competitive position in the marketplace.

B) A given operating cash flow in euro will be converted to a higher U.S. dollar cash flow.

C) The cash flow in euro could be altered due an alteration in the firm's competitive position in the marketplace, and a given operating cash flow in euro will be converted to a higher U.S. dollar cash flow.

D) none of the options Answer: C Topic: Illustration of Operating Exposure Accessibility: Keyboard Navigation 63) Consider a U.S.-based MNC with a wholly-owned Italian subsidiary. Following a depreciation of the dollar against the euro, which of the following describes the competitive effect of the depreciation?

A) The cash flow in euro could be altered due an alteration in the firm's competitive position in the marketplace.

B) A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow.

C) The cash flow in euro could be altered due an alteration in the firm's competitive position in the marketplace, and a given operating cash flow in euro will be translated to a higher U.S. dollar cash flow.

D) none of the options Answer: A Topic: Illustration of Operating Exposure Accessibility: Keyboard Navigation 64) Consider a U.S. MNC with operations in Great Britain. Which of the following are potential risks following a strengthening of the dollar?

A) A pound sterling depreciation may affect operating cash flow in pounds by altering the firm's competitive position in the marketplace.

B) A given operating cash flow in pounds will be converted into a lower dollar amount after the pound depreciation.

C) A pound sterling depreciation may affect operating cash flow in pounds by altering the firm's competitive position in the marketplace, and a given operating cash flow in pounds will be converted into a lower dollar amount after the pound depreciation.

D) none of the options Answer: C Topic: Illustration of Operating Exposure Accessibility: Keyboard Navigation

33 Copyright © 2018 McGraw-Hill

65) Which of the following is false?

A) The competitive effect is that a depreciation may affect operating cash flow in the foreign currency by altering the firm's competitive position in the marketplace.

B) The conversion effect is defined as a given operating cash flow in a foreign currency will be converted into a lower dollar amount after a currency depreciation.

C) The competitive effect is defined as a given operating cash flow in a foreign currency will be converted into a lower dollar amount after a currency depreciation.

D) none of the options Answer: C Topic: Illustration of Operating Exposure Accessibility: Keyboard Navigation 66) Consider a U.S.-based MNC with a wholly-owned German subsidiary. Following a depreciation of the dollar against the euro, which of the following describes the conversion effect of the depreciation?

A) The cash flow in euro could be altered due a change in the firm's competitive position in the marketplace.

B) A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow.

C) The cash flow in euro could be altered due a change in the firm's competitive position in the market place, and a given operating cash flow in euro will be translated to a higher U.S. dollar cash flow.

D) none of the options Answer: B Topic: Illustration of Operating Exposure Accessibility: Keyboard Navigation 67) Consider a U.S.-based MNC with a wholly-owned French subsidiary. Following a depreciation of the dollar against the euro, which of the following best describes the mechanism of any effect of the depreciation?

A) The change in the cash flow in euro due an alteration in the firm's competitive position in the marketplace is in part a function of the elasticity of demand for the firm's product.

B) A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow regardless of the firm's hedging program.

C) The change in the cash flow in euro due an alteration in the firm's competitive position in the marketplace is in part a function of the elasticity of demand for the firm's product, and a given operating cash flow in euro will be translated to a higher U.S. dollar cash flow regardless of the firm's hedging program.

D) none of the options Answer: A Topic: Illustration of Operating Exposure Accessibility: Keyboard Navigation

34 Copyright © 2018 McGraw-Hill

68) Which of the following is true?

A) The competitive effect is that a currency depreciation may affect operating cash flow in the foreign currency by altering the firm's competitive position in the marketplace.

B) The conversion effect is defined as a given accounting cash value in a foreign currency will be converted into a lower dollar amount after currency depreciation.

C) The competitive effect is defined as a given operating cash flow in a foreign currency will be converted into a lower dollar amount after a currency depreciation.

D) none of the options Answer: A Topic: Illustration of Operating Exposure Accessibility: Keyboard Navigation 69) Consider a U.S.-based MNC with a wholly-owned European subsidiary selling a product sourced in euro and priced in euro with inelastic demand. Following a depreciation of the dollar against the euro, which of the following is the truest?

A) Since they have inelastic demand, the U.S. firm can just pass through the impact of the exchange rate change.

B) Since they have elastic demand, the U.S. firm cannot just pass through the impact of the exchange rate change.

C) Since the exchange rate movement was favorable to the U.S. firm, there is no impact on the firm's position.

D) none of the options.

Answer: D Topic: Determinants of Operating Exposure Accessibility: Keyboard Navigation 70) A firm's operating exposure is A) defined as the extent to which the firm's operating cash flows would be affected by the random changes in exchange rates.

B) determined by the structure of the markets in which the firm sources its inputs, such as labor and materials, and sells its products.

C) determined by the firm's ability to mitigate the effect of exchange rate changes by adjusting its markets, product mix, and sourcing.

D) all of the options Answer: D Topic: Determinants of Operating Exposure Accessibility: Keyboard Navigation

35 Copyright © 2018 McGraw-Hill

71) Generally speaking, a firm is subject to high degrees of operating exposure A) when its costs are sensitive to exchange rate changes.

B) when its prices are sensitive to exchange rate changes.

C) when either its cost or its price is sensitive to exchange rate changes.

D) none of the options Answer: C Topic: Determinants of Operating Exposure Accessibility: Keyboard Navigation 72) Generally speaking, when both a firm's costs and its price are sensitive to exchange rate changes, A) the firm is not subject to high degrees of operating exposure.

B) the firm is subject to high degrees of operating exposure.

C) the firm should hedge.

D) none of the options Answer: A Topic: Determinants of Operating Exposure Accessibility: Keyboard Navigation 73) The firm may not be subject to high degrees of operating exposure A) when changes in real exchange rates are exactly offset by the inflation differential.

B) when changes in nominal exchange rates are exactly matched by the inflation differential.

C) when changes in nominal exchange rates are exactly offset by the inflation differential.

D) none of the options Answer: C Topic: Determinants of Operating Exposure Accessibility: Keyboard Navigation 74) The firm may not be able to pass through changes in the exchange rate A) in markets with low product differentiation.

B) in markets with high price elasticities.

C) in markets with low product differentiation or in markets with high price elasticities.

D) none of the options Answer: C Topic: Determinants of Operating Exposure Accessibility: Keyboard Navigation

36 Copyright © 2018 McGraw-Hill

75) The firm may not be able to pass through changes in the exchange rate A) in markets with mainly domestic (foreign to the firm) competitors.

B) in markets with low price elasticities.

C) in markets with mainly domestic (foreign to the firm) competitors or in markets with low price elasticities.

D) none of the options Answer: A Topic: Determinants of Operating Exposure Accessibility: Keyboard Navigation 76) Generally speaking, a firm is subject to high degrees of operating exposure when A) either its cost or its price is sensitive to exchange rate changes.

B) both the cost and the price are sensitive to exchange rate changes.

C) both the cost and the price are insensitive to exchange rate changes.

D) none of the options Answer: A Topic: Managing Operating Exposure Accessibility: Keyboard Navigation 77) What is the objective of managing operating exposure?

A) Stabilize cash flows in the face of fluctuating exchange rates.

B) Selecting low cost production sites.

C) Increase the variability of cash flows in the face of fluctuating exchange rates.

D) Stabilize cash flows in the face of fluctuating exchange rates, and increase the variability of cash flows in the face of fluctuating exchange rates.

Answer: A Topic: Managing Operating Exposure Accessibility: Keyboard Navigation 78) What is the objective of managing operating exposure?

A) Stabilize accounting results in the face of fluctuating exchange rates.

B) Selecting low cost production sites.

C) Increase the variability of cash flows in the face of fluctuating exchange rates.

D) none of the options Answer: D Topic: Managing Operating Exposure Accessibility: Keyboard Navigation

37 Copyright © 2018 McGraw-Hill

79) Managing operating exposure A) is a short-term tactical issue.

B) is a long-term issue, like selecting a site for a factory.

C) is relatively unimportant, since most MNCs have a built-in hedge.

D) none of the options Answer: B Topic: Managing Operating Exposure Accessibility: Keyboard Navigation 80) Which of the following can a company use to manage operating exposure?

A) Selecting low-cost production sites, diversifying the market.

B) Low cost production sites, but not financial hedging.

C) Pursuing a flexible sourcing policy, product differentiation, R&D efforts.

D) Selecting low-cost production sites, diversifying the market, as well as pursuing a flexible sourcing policy, product differentiation, R&D efforts.

Answer: D Topic: Managing Operating Exposure Accessibility: Keyboard Navigation 81) When the domestic currency is strong or expected to become strong, A) this could erode the competitive position of the firm's exports.

B) this could erode the competitive position of the firm's import competition.

C) the firm should consider locating production facilities in a foreign country where costs are low.

D) this could erode the competitive position of the firm's exports and the firm should consider locating production facilities in a foreign country where costs are low.

Answer: D Topic: Selecting Low-Cost Production Sites Accessibility: Keyboard Navigation 82) A foreign country could provide low cost production sites A) because the factors of production are underpriced.

B) because the currency is undervalued.

C) because the locals like to give away their land labor and capital to foreigners.

D) because the factors of production are underpriced and because the currency is undervalued.

Answer: D Topic: Selecting Low-Cost Production Sites Accessibility: Keyboard Navigation

38 Copyright © 2018 McGraw-Hill

83) While maintaining multiple production sites does provide a firm valuable options, A) a firm may miss out on economies of scope.

B) a firm may miss out on economies of scale.

C) a firm may find that exchange rate changes can fully offset the advantage of multiple manufacturing sites.

D) a firm may miss out on economies of scope and economies of scale.

Answer: B Topic: Selecting Low-Cost Production Sites Accessibility: Keyboard Navigation 84) Goldman Sachs estimates that as much as ________ percent of the pretax profits that Porsche reported for a recent fiscal year came from skillfully executing currency options.

A) 5 B) 10 C) 15 D) 75 Answer: D Topic: Selecting Low-Cost Production Sites 85) Developing multiple production sites in a variety of countries, A) can create an excess capacity problem.

B) can lead to underutilization of domestic plants.

C) can lead to domestic job losses.

D) all of the options Answer: D Topic: Selecting Low-Cost Production Sites Accessibility: Keyboard Navigation 86) A flexible sourcing policy A) is primarily concerned with low-cost (and often low-quality) vendors.

B) need not be confined just to materials and parts.

C) only works for manufacturing firms, not service firms.

D) puts the focus on the exchange rate at the expense of shipping rates.

Answer: B Topic: Flexible Sourcing Policy Accessibility: Keyboard Navigation

39 Copyright © 2018 McGraw-Hill

87) A firm that is committed to keeping manufacturing facilities in only the home country (and not developing multiple production sites in a variety of countries) can A) not mitigate the effects of exchange rate changes.

B) lessen the effect of exchange rate changes by sourcing from where input costs are low.

C) focus on selling commodity products with product differentiation.

D) pursue a strategy of increasing its products price elasticity of demand.

Answer: B Topic: Flexible Sourcing Policy Accessibility: Keyboard Navigation 88) If the domestic currency is strong or expected to become strong, A) a firm can choose to locate production facilities in a foreign country where costs are low due to either the undervalued currency or underpriced factors of production.

B) a firm should curtail R&D efforts until the exchange rate situation improves.

C) a firm should abandon international sales and focus on domestic market share.

D) the firm should focus on profiting in the currency futures market based on its forecasts.

Answer: A Topic: Flexible Sourcing Policy Accessibility: Keyboard Navigation 89) Which of the following is a true statement?

A) As long as exchange rates do not always move in the same direction, the firm can stabilize its operating cash flows by diversifying its export market.

B) The firm should not get into new lines of business solely to diversify exchange risk because conglomerate expansion can bring about inefficiency and losses.

C) all of the options above D) none of the options Answer: C Topic: Diversification of the Market Accessibility: Keyboard Navigation 90) A firm that is committed to keeping manufacturing facilities in only the home country (and not developing multiple production sites in a variety of countries) can A) lessen the effect of exchange rate changes by pursuing a strategy of diversifying the markets in which the firm's products are sold.

B) not mitigate the effects of exchange rate changes.

C) lessen the effect of exchange rate changes by pursuing a strategy of selling commodity products without product differentiation.

D) pursue a strategy of increasing its products price elasticity of demand.

Answer: A Topic: Diversification of the Market Accessibility: Keyboard Navigation 40 Copyright © 2018 McGraw-Hill

91) It can be argued that, while financial hedging can be used to stabilize a firm's cash flows, A) it is not a substitute for long-term operational hedging.

B) it is therefore a substitute for long-term operational hedging.

C) it is inferior to money market hedging.

D) none of the options.

Answer: A Topic: R&d Efforts and Product Differentiation; Financial Hedging Accessibility: Keyboard Navigation 92) Investments in R&D A) are usually a waste of time and money.

B) can allow the firm to maintain and strengthen its competitive position.

C) can allow the firm to cut costs and enhance productivity.

D) can allow the firm to maintain and strengthen its competitive position, as well as cut costs and enhance productivity.

Answer: D Topic: R&d Efforts and Product Differentiation; Financial Hedging Accessibility: Keyboard Navigation 93) The price elasticity of demand for unique products tends to be A) highly elastic.

B) highly inelastic.

C) highly elastic and highly inelastic.

D) none of the options Answer: B Topic: R&d Efforts and Product Differentiation; Financial Hedging Accessibility: Keyboard Navigation 94) The price elasticity of demand for commodity products tends to be A) highly elastic.

B) highly inelastic.

C) highly elastic and highly inelastic.

D) none of the options Answer: A Topic: R&d Efforts and Product Differentiation; Financial Hedging Accessibility: Keyboard Navigation

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95) In the figure below, label curves A and B are, respectively,

A) unhedged and hedged.

B) hedged and unhedged.

C) normal and abnormal.

D) none of the options Answer: A Topic: R&d Efforts and Product Differentiation; Financial Hedging 96) Investment in R&D activities can allow the firm to maintain and strengthen its competitive position in the face of adverse exchange rate movements. The mechanism for this includes A) successful R&D efforts allowing the firm to cut costs and enhance productivity.

B) R&D efforts leading to the introduction of new and unique products for which competitors offer no close substitutes—since the demand for unique products tends to be highly inelastic the firm would be less exposed to exchange risk.

C) successful R&D efforts creating a perception among consumers that its product is indeed different from those offered by competitors. Once the firm's product acquires a unique identity, its demand is less likely to be price-sensitive.

D) all of the options Answer: D Topic: R&d Efforts and Product Differentiation; Financial Hedging

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97) If the stock market of a foreign country is consistently up when the dollar value of the currency is down, A) there may not be a great deal of exchange rate risk for a U.S.-based investor.

B) there will be a great deal of exchange rate risk for a U.S.-based investor.

C) then investors can ignore diversification.

D) none of the options Answer: A Topic: R&d Efforts and Product Differentiation; Financial Hedging 98) Suppose that you hold a piece of land in the city of London that you may want to sell in one year. As a U.S. resident, you are concerned with the dollar value of the land. Assume that if the British economy booms in the future, the land will be worth £2,000, and one British pound will be worth $1.80. If the British economy slows down, on the other hand, the land will be worth less, say, £1,500, but the pound will be stronger, say, $2.20/£. You feel that the British economy will experience a boom with a 60 percent probability and a slowdown with a 40 percent probability.

Estimate your exposure (b) to the exchange risk.

Answer: b =

.

E[P] = 0.60 × £2,000 × $1.80 + 0.40 × £1,500 × $2.20/£ = $3,300 E(S) = 0.60 × $1.40 + 0.40 × $ 1.50 = $1.96 The variance of the exchange rate is: VAR(S) = 0.60($1.80 − $1.96)2 + 0.40($2.20 − $1.96)2 = 0.0534150 Cov(P,S) = 0.60 × ($3,600− $3,300) × ($2.50 − $1.96) + 0.40 × ($3,300 − $3,300) × ($2.00 − $1.96) = 11.52 + 17.28 = 28.80 b

=

.

Topic: Operating Exposure: Definition

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99) Suppose that you hold a piece of land in the city of London that you may want to sell in one year. As a U.S. resident, you are concerned with the dollar value of the land. Assume that if the British economy booms in the future, the land will be worth £2,000, and one British pound will be worth $1.80. If the British economy slows down, on the other hand, the land will be worth less, say, £1,500, but the pound will be stronger, say, $2.20/£. You feel that the British economy will experience a boom with a 60 percent probability and a slowdown with a 40 percent probability.

Compute the variance of the dollar value of your property that is attributable to exchange rate uncertainty.

Answer: The expression "b2VAR(S)" represents the volatility of the dollar value of the asset that is related to random changes in the exchange rate. 15,528 = b2VAR(S) From the results to earlier questions we have the values: V AR(S) = 0.0534150 b = 539.17 Therefore, using the Equation 9.2, we obtain V(P) = VAR(S) + VAR(e) 498,960 = 15,528 + VAR(e) VAR(e) = 498,960 − 15,528 = 483,432 The expression "VAR(e)" is the volatility in the dollar value of the asset that is independent of exchange rate movements.

Topic: Operating Exposure: Definition 100) Suppose that you hold a piece of land in the city of London that you may want to sell in one year. As a U.S. resident, you are concerned with the dollar value of the land. Assume that if the British economy booms in the future, the land will be worth £2,000, and one British pound will be worth $1.80. If the British economy slows down, on the other hand, the land will be worth less, say, £1,500, but the pound will be stronger, say, $2.20/£. You feel that the British economy will experience a boom with a 60 percent probability and a slowdown with a 40 percent probability.

Discuss how you can hedge your exchange risk exposure and also examine the consequences of hedging.

Answer: You could sell b = £539.17 forward. However, exchange rate movements only account for a small amount of the volatility in the dollar value of the asset (3%). What we really have is a play on the state of the British economy, not on the exchange rate.

Topic: Operating Exposure: Definition

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