Chapter 12 Managing Economic Exposure and Translation Exam Study Guide. Comprehensive Late, Exams of Economics

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1. Depreciation of the euro relative to the U.S. dollar will cause a U.S.-based multinational firm's reported earnings (from the consolidated income statement) to. If a firm desired to protect against this possibility, it could stabilize its reported earnings by euros forward in the foreign exchange market. a. be reduced; purchasing b. be reduced; selling c. increase; selling d. increase; purchasing

ANS: B PTS: 1

2. Springfield Co., based in the U.S., has a cost from orders of foreign material that exceeds its foreign revenue. All foreign transactions are denominated in the foreign currency of concern. This firm would a stronger dollar and would a weaker dollar. a. benefit from; be unaffected by b. benefit from; be adversely affected by c. be unaffected by; be adversely affected by d. be unaffected by; benefit from e. benefit from; benefit from

ANS: B PTS: 1

3. Whitewater Co. is a U.S. company with sales to Canada amounting to C$8 million. Its cost of materials attributable to the purchase of Canadian goods is C$6 million. Its interest expense on Canadian loans is C$4 million. Given these exact figures above, the dollar value of Whitewater's "earnings before interest and taxes" would if the Canadian dollar appreciates; the dollar value of Whitewater's cash flows would if the Canadian dollar appreciates. a. increase; increase b. decrease; increase c. decrease; decrease d. increase; decrease e. increase; be unaffected

ANS: D PTS: 1

4. Sycamore (a U.S. firm) has no subsidiaries and presently has sales to Mexican customers amounting to MXP98 million, while its peso-denominated expenses amount to MXP41 million. If it shifts its material orders from its Mexican suppliers to U.S. suppliers, it could reduce peso-denominated expenses by MXP12 million and increase dollar-denominated expenses by $800,000. This strategy would the Sycamore's exposure to changes in the peso's movements against the U.S. dollar. Regardless of whether the firm shifts expenses, it is likely to perform better when the peso is valued relative to the dollar. a. reduce; high b. reduce; low c. increase; low

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a. An increase in the dollar's value hurts a U.S. firm's domestic sales because foreign competitors are able to increase their sales to U.S. customers. b. An increase in the pound's value increases the U.S. firm's cost of British pound payables. c. A decrease in the peso's value decreases a U.S. firm's dollar value of peso receivables. d. A decrease in the Swiss franc's value decreases the dollar value of interest payments on a Swiss deposit sent to a U.S. firm by a Swiss bank.

ANS: A PTS: 1

6. Rockford Co. is a U.S. manufacturing firm that produces goods in the U.S. and sells all products to retail stores in the U.K.; the goods are denominated in pounds. It finances a small portion of its business with pound-denominated loans from British banks. Which of the following is true? (Assume that the amount of products to be sold is guaranteed by contracts.) a. The dollar value of sales is higher if the pound depreciates against the dollar. b. The dollar value of sales is unaffected by the pound's exchange rate. c. A and B d. None of the above

ANS: D PTS: 1

7. If a U.S. firm's expenses are more susceptible to exchange rate movements than revenue, the firm will if the dollar. a. benefit; weakens b. be unaffected; weakens c. be unaffected; strengthens d. benefit; strengthens

ANS: D PTS: 1

8. Laketown Co. has some expenses and revenue in euros. If its expenses are more sensitive to exchange rate movements than revenue, it could reduce economic exposure by. If its revenues are more sensitive than expenses, it could reduce economic exposure by. a. decreasing foreign revenues; decreasing foreign expenses b. decreasing foreign revenues; increasing foreign expenses c. increasing foreign revenues; decreasing foreign revenues d. decreasing foreign expenses; increasing foreign revenues

ANS: D PTS: 1

9. Any restructuring of operations that the difference between a foreign currency's inflows and outflows may economic exposure. a. reduces; increase b. increases; reduce c. reduces; reduce d. A and B e. none of the above

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ANS: C PTS: 1

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a. using the money market hedge. b. using the forward hedge. c. using the futures hedge. d. none of the above, since a perfect hedge is nearly impossible.

ANS: D PTS: 1

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16. Assume that a Japanese car manufacturer exports cars to U.S. dealerships, which are priced in yen. The demand for those cars declines when the yen is strong. The manufacturer also produces some cars in the U.S. with U.S. materials and those cars are priced in dollars. The manufacturer could reduce its economic exposure by: a. closing down most of its plants in the U.S. b. producing more automobiles in the U.S. c. relying completely on Japanese suppliers for its parts. d. pricing its exports in dollars.

ANS: B PTS: 1

17. Wisconsin Inc. conducts business in Zambia. Years ago, Wisconsin established a subsidiary in Zambia that has consistently generated very large profits denominated in Zambian kwacha. Wisconsin wishes to restructure its operations to reduce economic exposure. Which of the following is not a feasible way of accomplishing this? a. increase Zambian supply orders. b. increase Zambian sales. c. restructure debt to increase debt payments in Zambia. d. reduce Zambian sales.

ANS: B PTS: 1

18. Which of the following firms is not exposed to translation exposure? a. Firm X, with a fully owned subsidiary that periodically remits earnings generated in Great Britain to the U.S.-based parent. b. Firm Y, with a fully owned subsidiary that periodically generates foreign losses in Sweden. The parent covers at least some of these losses. c. Firm Z, with a fully owned subsidiary that generates substantial earnings in Germany. The subsidiary never remits earnings but reinvests them in Germany. d. All of the above firms are exposed to translation exposure.

ANS: D PTS: 1

19. represents any impact of exchange rate fluctuations on a firm's future cash flows. a. Translation exposure b. Economic exposure c. Transaction exposure d. None of the above

ANS: B PTS: 1

20. An effective way for an MNC to assess its economic exposure is to review the firm's: a. income statement. b. liquidity. c. retained earnings.

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21. If revenues and costs are equally sensitive to exchange rate movements, MNCs may reduce their economic exposure by restructuring their operations to shift the sources of costs or revenues to other locations so that: a. cash inflows exceed cash outflows in each foreign currency. b. cash outflows exceed cash inflows in each foreign currency. c. cash inflows match cash outflows in each foreign currency. d. none of the above

ANS: C PTS: 1

22. Managing economic exposure is generally perceived to be managing transaction exposure. a. more difficult than b. less difficult than c. just as difficult as d. none of the above

ANS: A PTS: 1

23. As opposed to transaction exposure, managing economic exposure involves developing a(n) solution. a. short-term b. long-term c. immediate d. none of the above

ANS: B PTS: 1

24. Cierra, Inc. is attempting to assess its degree of economic exposure in euros. In order to do so, it has applied regression analysis to determine whether the percentage change in its total cash flow is related to the percentage change in the euro. A and statistically significant slope coefficient resulting from this analysis implies that the cash flows are related to the percentage changes in the euro. a. positive; positively b. positive; negatively c. negative; positively d. B and C e. none of the above

ANS: A PTS: 1

25. Assume that an MNC's cash flows are positively related to the movements in a foreign currency. If the MNC expects the foreign currency to weaken, it could purchase the currency forward to reduce its degree of economic exposure. a. True b. False

ANS: F PTS: 1

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26. An MNC is attempting to reduce its economic exposure by financing a portion of its business with loans in the foreign currency. If the foreign currency weakens, the MNC will need of the foreign currency to cover the loan payment, while the MNC's foreign currency revenues will convert to dollars. a. more; fewer

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e. none of the above

ANS: B PTS: 1

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32. Translation losses are , while gains on forward contracts used to hedge translation exposure are . a. tax deductible; not taxed b. not tax deductible; not taxed c. not tax deductible; taxed d. tax deductible; taxed

ANS: D PTS: 1

33. In general, it is more difficult to effectively hedge economic or translation exposure than to hedge transaction exposure. a. True b. False

ANS: T PTS: 1

34. A foreign subsidiary with more susceptible expenses than revenue to exchange rate movements will be favorably affected by an appreciation of the foreign currency. a. True b. False

ANS: F PTS: 1

35. U.S. firms can attempt to hedge their translation exposure of their European subsidiaries with a forward purchase of euros. a. True b. False

ANS: F PTS: 1

36. Hedging translation exposure with forward contracts can backfire if the currency being hedged depreciates. a. True b. False

ANS: F PTS: 1

37. A limitation of hedging translation exposure is that translation losses are not tax deductible, whereas gains on forward contracts used to hedge translation exposure are taxed. a. True b. False

ANS: T PTS: 1

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39. All MNCs are subject to translation exposure. a. True b. False

ANS: F PTS: 1

40. U.S.-based MNCs invoicing in Asian currencies and incurring expenses in Asian currencies were probably less affected by the weakness of Asian currencies than U.S.-based MNCs that invoice in Asian currencies but do not incur expenses in those currencies. a. True b. False

ANS: T PTS: 1

41. The management of economic exposure is normally focused completely on transactions that will occur in the next three months. a. True b. False

ANS: F PTS: 1

42. Transaction exposure results when an MNC translates each subsidiary's financial data to its home currency for consolidated financial statements. a. True b. False

ANS: F PTS: 1

43. Although forward contracts may reduce translation exposure at the expense of increasing transaction exposure, they are sometimes used to hedge translation exposure. a. True b. False

ANS: T PTS: 1

44. Vermont Co. has foreign expenses denominated in euros that exceed foreign revenues. Appreciation of the euro relative to the U.S. dollar will cause this firm's reported earnings (from the consolidated income statement) to. If a firm desired to protect against this possibility, it could stabilize its reported earnings by euros forward in the foreign exchange market. a. decrease; purchasing b. decrease; selling c. increase; selling d. increase; purchasing

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ANS: A PTS: 1

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operations are expected to be C$500,000 next year. The Canadian dollar is valued at about $.90. The net cash flows from U.S. operations are supposed to be $200,000. To reduce sensitivity of its net cash flows without reducing its volume of business in Canada, Tennessee Co. could: a. purchase Canadian supplies. b. increase its borrowings in U.S. c. decrease prices on Canadian goods.

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d. decrease its borrowed funds in Canada.

ANS: A PTS: 1

50. Mercury Co. has a subsidiary based in Italy and is exposed to translation exposure. Mercury forecasts that its earnings next year will be €10 million. Mercury decides to hedge the expected earnings by selling €10 million forward. During the next year, the euro appreciated. Mercury's consolidated earnings were affected by the euro's movement, and Mercury's hedge position was affected by the euro's movement. a. favorably; favorably b. favorably; adversely c. adversely; favorably d. adversely; adversely

ANS: B PTS: 1

51. All MNCs are subject to transaction exposure. a. True b. False

ANS: F PTS: 1

52. A foreign subsidiary with more revenue than expenses denominated in a foreign currency will be favorably affected by appreciation of the foreign currency. a. True b. False

ANS: T PTS: 1

53. Economic exposure represents any impact of exchange rate fluctuations on a firm's future cash flows and thus includes transaction exposure. a. True b. False

ANS: T PTS: 1

54. In general, it is more difficult to effectively hedge economic or translation exposure than to hedge transaction exposure. a. True b. False

ANS: T PTS: 1

55. To reduce economic exposure when a foreign currency has a greater impact on cash inflows, an MNC could reduce its level of foreign sales, increase its foreign supply orders, or restructure debt to increase debt payments in the foreign currency.