Parity Conditions in International Finance and Currency Forecasting EASY (Definitional)

Shapiros Multinational Financial Management, 9th Edition
Test Bank
CHAPTER 4
Parity Conditions in International Finance and Currency Forecasting
EASY (definitional)
4.1 In its absolute version, purchasing power parity states that price levels worldwide should be
_______when expressed in a common currency.
a) equal
b) roughly equal
c) different
d) opportunities for arbitrage
Ans: a
Section: Purchasing power parity
Level: Easy
4.2 The theory of relative purchasing power parity states that, between two nations, the
a) inflation rates are unrelated
b) exchange rate differential reflects the inflation rate differential
c) inflation rate is smaller in weaker currencies
d) the interest rate is greater than the inflation rate during depreciations
Ans: b
Level: Easy
4.3 The Fisher effect states that the _________ rate is made up of a real required rate of return
and an inflation premium.
a) nominal exchange
b) real exchange
c) nominal interest
d) adjusted dividend
Ans: c
Section: The fisher effect
Level: Easy
4.4 A rise in the inflation rate in one nation relative to others will be associated with a fall in the
first nations exchange rate and with a rise of its interest rate relative to foreign interest rates.
The two conditions combined result in the _________ Effect.
a) Fisher
b) Herstatt
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c) Unbiased forward rate

d) International Fisher
Ans: d
Level: Easy
MEDIUM (applied)
4.5 Suppose annual inflation rates in the U.S. and Mexico are expected to be 6% and 80%,
respectively, over the next several years. If the current spot rate for the Mexican peso is $.005,
then the best estimate of the peso's spot value in 3 years is
a) $.00276
b) $.01190
c) $.00321
d) $.00102
Ans: d
Level: Medium
4.6 If the expected inflation rate is 5% and the real required return is 6%, then the Fisher effect
says that the nominal interest rate should be
a) 1%
b) 11.3%
c) 11%
d) 6%
Ans: b
Level: Medium
4.7 The inflation rates in the U.S. and France in January 1991 were expected to be 4% per
annum and 7% per annum, respectively. If the current spot rate that day was $.1050, then the
expected spot rate in three years was
a) $.1150
b) $.1112
c) $.0964
d) $.0992
Ans: c
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Level: Medium
4.8 Suppose the expected inflation in the U.S. on January 1, 1988 was projected at 5% annually
for the next 5 years and at 12% annually in Italy for the same time period, and the lira/$ spot
rate that day was currently at L2400 = $1, then the PPP estimate of the spot rate five years from
now was
a) 1738
b) 3314
c) 2560
d) 2250
Ans: b
Level: Medium
4.9 If expected inflation is 20% and the real required return is 10%, then the Fisher effect says
that the nominal interest rate should be exactly
a) 30%
b) 32%
c) 22%
d) 12%
Ans: b
Level: Medium
4.10 On January 1, 1990, the annual inflation rates in the U.S. and Greece were expected to be
3% and 8%, respectively. If the current spot rate that day for the drachma was $.007, then the
expected spot rate in three years was
a) $.00607
b) $.00823
c) $.00751
d) $.00694
Ans: a
Level: Medium
4.11 If a country's freely floating currency is undervalued in terms of purchasing power parity,
its capital account is likely to be
a) in deficit or tending toward a deficit
b) in surplus or tending toward a surplus
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c) Subsidized by the International Monetary Fund

d) a candidate for loans from the World Bank
Ans: a
Level: Medium
4.12 If the rate of inflation in all of the worlds currency markets rises from 5% to 7%, this will
tend to make forward exchange rates move toward
a) smaller premiums or larger discounts in relation to the dollar
b) larger premiums or smaller discounts in relation to the dollar
c) no change on average
d) parity
Ans: c
Level: Medium
4.13 A 150% real return in Brazil is higher than a 15% dollar return in the U.S.
a) because arbitrage opportunities exist
b) when the inflation controls are suspended in Brazil
c) it depends on whether these are nominal or real returns
d) regardless of nominal or real returns
Ans: c
Level: Medium
4.14 On January 1, 1994, the annual inflation rates in the U.S. and Italy were expected to be 4%
and 7%, respectively. If the current spot rate on that day was $1 = L2,000, then the expected
spot rate for the lira in three years was
a) $.0004591
b) $.0011590
c) $.0009892
d) $.0005471
Ans: a
Level: Medium
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4.15 On January 1, 1985, the annual inflation rates in the U.S. and France were expected to be
4% and 6%, respectively. If the current spot rate that day was $.1250, then the expected spot
rate in two years was
a) $.1299
b) $.1150
c) $.1203
d) $.1335
Ans: c
Level: Medium
4.16 Suppose five-year deposit rates on Eurodollars and Euro marks are 12% and 8%,
respectively. If the current spot rate for the mark is $0.50, then the spot rate for the mark five
years from now implied by these interest rates is
a) .5997
b) .4169
c) .5185
d) .4821
Ans: a
Section: The international fisher effect
Level: Medium
4.17 The direct spot quote for the Canadian dollar is $.76 and the 180-day forward rate is $.74.
The difference between the two rates is likely to mean that
a) inflation in the U.S. during the past year was lower than in Canada
b) interest rates are rising faster in Canada than in the U.S.
c) prices in Canada are expected to rise more rapidly than in the U.S.
d) the Canadian dollar's spot rate is expected to rise in terms of the U.S. dollar
Ans: c
Section: Interest rate parity theory
Level: Medium
4.18 Suppose that on January 1, 1987, the spot rate on the Dutch guilder was $0.39 and the
180-day forward rate was $0.40. The difference between the spot and forward rates suggested
that
a) interest rates were higher in the U.S. than in the Netherlands
b) the guilder had risen in relation to the dollar
c) the inflation rate in the Netherlands was declining
d) the guilder was expected to fall in value relative to the dollar
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Ans: a
Level: Medium
4.19 Suppose the price indexes in Mexico and the U.S., which both began the year at 100, are
at 160 and 103, respectively, by the end of the year. If the exchange rate began the year at
Mex$4.5 = $1 and ended the year at Mex$5.9 = $1, then the change in the real value of the peso
during the year is (a "-" indicates a real devaluation)
a) 0.0%
b) -5.0%
c) 18.5%
d) -8.2%
Ans: c
Level: Medium
4.20 Suppose the spot rates for the pound, mark, and Swiss franc prior to 1999 were $1.20,
$.32, and $.40, respectively. At the same time, the associated 90-day interest rates (annualized)
were 16%, 8%, and 4%, while the U.S. 90-day interest rate was 12%. What was the 90-day
forward rate (to the nearest cent) on a TCU (TCU 1 = 1 + DM1 + SFr1) if interest parity were
to hold?
a) $1.92
b) $1.98
c) $1.94
d) $1.87
Ans: a
Level: Medium
4.21 The current five-year Euro yen rate is 6% per annum (compounded annually). The
five-year Eurodollar rate is 8.5%. What is the implied forward premium or discount of the yen
(over the current spot rate) for a five-year forward contract?
a) 4.17% premium
b) 18.46% discount
c) 11.00% discount
d) 12.36% premium
Ans: d
Level: Medium
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4.22 Suppose the spot rates on January 1, 1992 for the pound, mark, and Swiss franc were
$1.50, $.42, and $.48, respectively. At the time, the associated 90-day interest rates (annualized)
were 12%, 6%, and 4%, while the U.S. 90-day interest rate (annualized) was 8%. What was the
90-day forward rate on a DCU (DCU 1 = 1 + DM1 + SFr1) if interest parity were to hold?
a) $2.4027
b) $2.3923
c) $2.4196
d) $2.3738
Ans: b
Level: Medium
4.23 Suppose it is January 1, 1998 and spot pounds are selling at $1.7342, while 90-day
forward pounds are selling at $1.7156. At the same time, DM spot and 90-day forward rates are
$0.6138 and $0.6014, respectively. According to these quotes the
a) pound is selling at a 3.87% forward discount relative to the DM
b) pound is selling at a 2.37% forward premium relative to the DM
c) DM is selling at a 0.97% forward discount relative to the pound
d) DM is selling at a 1.54% forward premium relative to the pound
Ans: a
Level: Medium
4.24 If annualized interest rates in the U.S. and France on January 1, 1991 are 9% and 13%,
respectively, and the spot value of the franc is $.1109, then at what 180-day forward rate will
interest rate parity hold?
a) $.1070
b) $.1150
c) $.1088
d) $.1130
Ans: c
Level: Medium
4.25 If annualized interest rates in the U.S. and Switzerland are 10% and 4%, respectively, and
the 90-day forward rate for the Swiss franc is $.3864, at what current spot rate will interest rate
parity hold?
a) $.3902
b) $.3874
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c) $.3807
d) $.3792
Ans: c
Level: Medium
4.26 The spot rate on the euro is $1.33 and the 180-day forward rate is $1.34. The difference
between the two rates means
a) interest rates are higher in the U.S. than in Germany
b) the euro has risen in relation to the dollar
c) the inflation rate in Germany is declining
d) the euro is expected to fall in value relative to the dollar
Ans: a
Level: Medium
4.27 It is July 1, 1990. Suppose the spot rates for the pound, mark, and Swiss franc are $1.30,
$.35, and $.40, respectively. The associated 90-day interest rates (annualized) are 16%, 8%, and
4%, while the U.S. 90-day interest rate (annualized) is 12%. What is the 90-day forward rate on
an ACU (ACU 1 = 1 + DM1 + SFr1) if interest parity holds?
a) $2.0512
b) $2.1134
c) $2.0397
d) $2.0489
Ans: d
Level: Medium
4.28 The current five-year Euro yen and Eurodollar rates are 8% and 12.5% per annum,
respectively. What is the implied forward premium or discount of the yen (over the current spot
rate for a five-year forward contract)?
a) 4.17% premium
b) 18.46% discount
c) 17.74% discount
d) 22.64% premium
Ans: d
Level: Medium
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4.29 The 90-day interest rates (annualized) in the U.S. and Japan are, respectively, 10% and
7%, while the direct spot quote for the yen in New York is $.004300. At what 90-day forward
rate would interest rate parity hold?
a) .004430
b) .004271
c) .004332
d) .004176
Ans: c
Level: Medium
4.30 If annualized interest rates on January 1, 1985 in the U.S. and France were 9% and 13%,
respectively, and the spot value of the franc was $.1109, then at what 180-day forward rate
would interest rate parity hold?
a) $.1070
b) $.1150
c) $.1088
d) $.1130
Ans: c
Level: Medium
DIFFICULT (applied)
4.31 Suppose the pound devalues from $1.25 at the start of the year to $1.00 at the end of the
year. Inflation during the year is 15% in England and 5% in the U.S. What is the real
devaluation (-) or real revaluation (+) of the pound during the year?
a) - 12.38%
b) - 20.71%
c) + 2.39%
d) + 1.46%
Ans: a
Level: Difficult
4.32 Suppose it is May 1, 1981 and the price indexes in Spain and the U.S., which both began
the year at 100, are at 117 and 105, respectively, by the end of the year. If the beginning and
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ending exchange rates, respectively, for the peseta are $.1320 and $.1125, then the change in the
real value of the peseta (a "-" indicates a real devaluation) during the year is
a) 0%
b) -5.0%
c) 2.4%
d) -8.2%
Ans: b
Level: Difficult
4.33 Suppose the Swiss franc revalues from $0.40 at the beginning of the year to $0.44 at the
end of the year. U.S. inflation is 5% and Swiss inflation is 3% during the year. What is the real
devaluation (-) or real revaluation (+) of the Swiss franc during the year?
a) + 7.9%
b) - 5.3%
c) + 8.1%
d) - 1.6%
Ans: a
Level: Difficult
4.34 Suppose the value of the Polish zloty moves from Z 1000 = $1 at the start of the year to Z
1,800 at the end of the year. At the same time, the Polish price level changes from an index of
100 on January 1 to 134 on December 31. U.S. inflation during the year was 4.5%. If the oneyear interest rate on the zloty is 44%, what was the real dollar cost of borrowing the zloty
during the year?
a) 17.53%
b) 27.81%
c) -23.44%
d) -8.76%
Ans: c
Level: Difficult
4.35 Suppose it is October 1, 1990 and inflation rates in the U.S. and France are expected to be
4% and 9%, respectively, next year and 6% and 7%, respectively, in the following year. If the
current spot rate is $.1050, then the expected spot value of the franc in two years is
a) $.1111
b) $.1024
c) $.0992
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d) $.1074
Ans: c
Level: Difficult
4.36 Suppose it is January 1, 1994 and the Deutsche mark revalues from $.30 at the beginning
of the year to $.33 at the end of the year. Inflation during the year is 5% in the U.S. and 3% in
Germany. What is the real devaluation (-) or real revaluation (+) of the Deutsche mark during
the year?
a) + 7.9%
b) - 5.3%
c) + 8.1%
d) - 1.6%
Ans: a
Level: Difficult
4.37 If the U.S. trade balance with Japan is expected to go from a deficit this year to a surplus
next year, the forward rate on yen would
a) be less than the spot rate
b) be higher than the spot rate
c) equal the spot rate
d) could be either above or below the spot rate
Ans: d
Section: The relationship between the forward rate and the future spot rate
Level: Difficult
4.38 The following exchange and interest rate quotations in 1998 were observed:
Eurocurrency rates
Exchange rate per $
90-days (% annum)
(Discretely-compounded)
90-day
forward
Spot
DM
DM
DM
Bid:
15 5/8
7 7/8
12 1/4
1.881
.4961
1.801
.4937
Ask:
16
8 1/4
13
1.843
.4902
1.773
.4889
An arbitrage profit can be obtained by

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a)
b)
c)
d)
borrowing pounds and lending dollars

borrowing dollars and lending DM
borrowing DM and lending pounds
there are no arbitrage opportunities
Ans: a
Section: Interest rate and parity theory
Level: Difficult
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CHAPTER 8
Currency Futures and Options Markets
EASY (definitional)
8.1 Which one of the following currency futures contracts is currently NOT available?
a) French franc
b) Hungarian forint
c) Czech koruna
d) Norwegian krone
Ans: a
Section: Futures contracts
Level: Easy
8.2 Which of the following has provided a major inducement for speculators to participate in the
futures market?
a) low margin requirements
b) low bid-ask spreads
c) high volume compared to the forward market
d) all of the above
Ans: a
Section: Forward contracts versus futures contracts
Level: Easy
8.3 Options traded in the interbank market are known as
a) listed options
b) exchange-traded options
c) over-the-counter options
d) long-term options
Ans: c
Section: Future contracts
Level: Easy
8.4 Major advantages of futures contracts include the
a) large number of currencies traded
b) extensive delivery dates available
c) freedom to liquidate the contract at any time before its maturity
d) unlimited contract sizes
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Ans: c
Section: Advantages and disadvantages of future contracts
Level: Easy
8.5 The major disadvantage of forward and futures contracts relative to options is that the
forwards and futures contracts
a) cannot protect the holder against the risk of adverse movements in exchange rates
b) are more expensive
c) are available only for relatively short maturities
d) eliminate the possibility of gaining a windfall profit from favorable movements in exchange
rates
Ans: d
Section: Advantages and disadvantages of future contracts
Level: Easy
8.6 Suppose the current spot rate for the euro is $1.3427. A call option with an exercise price of
$1.3550 is said to be
a) in-the-money
b) out-of-the-money
c) at-the-money
d) past breakeven
Ans: b
Section: Using currency options
Level: Easy
8.7 Suppose the current spot rate for the pound is $01.7427. A put option with an exercise price
of $01.7550 is said to be
a) in-the-money
b) out-of-the-money
c) at-the-money
d) past breakeven
Ans: a
Section: Using currency options
Level: Easy
MEDIUM (applied)
8.8 The basic difference(s) between forward and futures contracts is that
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a) forward contracts are individually tailored while futures contracts are standardized
b) forward contracts are negotiated with banks whereas futures contracts are bought and sold on
an organized exchange
c) forward contracts have no daily limits on price fluctuations whereas futures contracts have a
daily limit on price fluctuations
d) all of the above
Ans: d
Section: Forward contract versus futures contract
Level: Medium
8.9 Suppose the current spot rate for the Australian dollar is U.S.$0.8321. The intrinsic value of
an A$50,000 call option with an exercise price of U.S.$0.8195 is
a) $0
b) $630
c) $740
d) $2,340
Ans: b
Section: Option pricing and valuation
Level: Medium
8.10 The time value of a European option
a) is always positive for an out-of-the-money option
b) is always positive for an in-the-money option
c) is always positive for an at-the-money option
d) decreases with the time that remains until the option expires
Ans: a
Level: Medium
8.11 You can speculate on pound depreciation by
a) selling pound futures and buying a pound call option
b) buying pound futures and a pound put option
c) selling pound futures and a pound put option
d) none of the above
Ans: d
Section: Using forward or futures contracts versus options
Level: Medium
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DIFFICULT (applied)
8.12 Suppose you are holding a long position in a euro futures contract that matures in 76 days.
The agreed-upon price is $1.15 for 125,000 euro. At the close of trading today, the futures price
has risen to $1.155. Under marking to market, you now
a) hold a futures contract that has risen in value by $1,250
b) hold a futures contract that has fallen in value by $625
c) will receive $625 and a new futures contract priced at $1.155
d) must pay over $1,250 to the seller of the futures contract
Ans: c
Section: Computing gains, losses and maintenance margins
Level: Difficult
8.13 Suppose that the interbank forward bid for March 20 on Swiss francs is $0.7827 at the
same time that the price of IMM Swiss franc futures for delivery on March 20 is $0.7795. How
much of an arbitrage profit could a dealer earn per March Swiss franc futures contract of SFr
125,000?
a) $400
b) $68
c) $215
d) $58
Ans: a
Section: Arbitrage between the futures and forward markets
Level: Difficult
8.14 Suppose it is May 1998 and the current spot rate for the DM is $0.5925. The call premium
on a call option with an exercise price of $0.5675 is $0.0373. What is the time value of one DM
62,500 call option?
a) $2,331.25
b) $1,562.50
c) $950.00
d) $768.75
Ans: d
Level: Difficult
8.15 Suppose it is January 1990 and the current spot rate for the DM is $0.5925. The call
premium on a call option with an exercise price of $0.5675 is $0.0373. What is the intrinsic
value of one DM 62,500 call option?
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a)
b)
c)
d)
Test Bank
$2,331.25
$1,562.50
$950.00
$768.75
Ans: b
Level: Difficult
8.16 The value of a European option always
a) exceeds its intrinsic value
b) rises with the time to maturity
c) rises with the interest rate
d) rises with the volatility of the exchange rate
Ans: d
Level: Difficult
8.17 A rise in the domestic interest rate will
a) raise the value of foreign-currency call options and reduce the value of foreign-currency put
options
b) raise the value of foreign-currency put options and reduce the value of foreign-currency call
options
c) raise the value of both foreign-currency put and call options
d) reduce the value of both foreign-currency put and call options
Ans: a
Level: Difficult
18 A rise in the foreign interest rate will
a) raise the value of foreign-currency call options and lower the value of foreign-currency put
options
b) raise the value of foreign-currency put options and lower the value of foreign-currency call
options
c) raise the value of both foreign-currency put and call options
d) reduce the value of both foreign-currency put and call options
Ans: b
Level: Difficult
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8.19 You can speculate on an appreciation of the Japanese yen by

a) selling a yen put option and buying a yen call option.
b) selling a yen put option and selling a yen call option.
c) buying a yen put option and selling a yen call option.
d) buying a yen put option and buying a yen call option.
Ans: a
Level: Difficult
8.20 Fluor Corporation has just made a French euro bid on a major project located in France. It
won't find out for 60 days whether it has won the contract. There will be a 10% signing bonus
payable to the winner in euros. The best way to protect against currency risk on its bid is for
Fluor to
a) buy a euro futures contract.
b) sell a euro call option.
c) sell a euro futures contract.
d) buy a euro put option.
Ans: d
Section: Using forward or futures contracts versus options contracts
Level: Difficult
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CHAPTER 10
Measuring and Managing Translation and Transaction Exposure
EASY (definitional)
10.1 ___________ a certain currency exposure means establishing an offsetting currency
position so that the gain or loss from the exposure on the original currency is exactly offset buy
the gain or loss from the currency hedge.
a) Arbitraging
b) Cross-hedging
c) Hedging
d) Risk shifting
Ans: c
Section: Alternative measures of foreign exchange exposure
Level: Easy
10.2 Hedging cannot provide protection against ________ exchange rate changes.
a) expected
b) nominal
c) real
d) pegged
Ans: a
Section: Designing a hedging strategy
Level: Easy
10.3 The basic hedging strategy involves
a) reducing hard currency assets and soft currency liabilities
b) increasing hard currency liabilities and soft currency assets
c) reducing soft currency assets and hard currency liabilities
d) converting soft currencies to hard currencies and lending hard currencies
Ans: c
Level: Easy
10.4 Translation exposure reflects the exposure of a company's
a) foreign operations to currency movements
b) foreign sales to currency movements
c) financial statements to currency movements
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d) cash flows to currency movements

Ans: c
Section: Alternative currency translation methods
Level: Easy
10.5 The current standard for measuring translation exposure is
a) the current/noncurrent method
b) the monetary/nonmonetary method
c) FASB 8
d) FASB 52
Ans: d
Section: Statement of financial accounting standards No. 52
Level: Easy
10.6 Under FASB 52, most financial statements must be translated using the
a) monetary/nonmonetary method
b) current/noncurrent method
c) current rate method
d) temporal method
Ans: c
Section: Statement of financial accounting standards No. 52
Level: Easy
10.7 Firms that attempt to reduce risk and beat the market simultaneously may end up with
a) more risk, not less
b) less risk
c) a profit as well as reduced risk
d) a loss as well as reduced risk
Ans: a
Level: Easy
10.8 One argument that favors centralization of foreign risk management is the ability to take
advantage of the portfolio effect through ________.
a) risk shifting
b) risk sharing
c) offshore banking
d) exposure netting
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Ans: d
Section: Centralization versus decentralization
Level: Easy
10.9 In a forward market hedge, a company that is long a foreign currency will _______ the
foreign currency forward, whereas a company that is short a foreign currency will _______ the
currency forward.
a) buy; sell
b) sell; buy
c) borrow; sell
d) lend; buy
Ans: b
Section: Managing a Transaction Exposure
Level: Easy
10.10 A ________ involves simultaneously borrowing and lending activities in two different
currencies to lock in the currencys value of a future foreign currency cash flow.
a) forward contract
b) currency collar
c) money-market hedge
d) currency option
Ans: c
Section: Money-market hedge
Level: Easy
10.11 A __________ involves offsetting exposures in one currency with exposures in the same
or another currency, where exchange rates are expected to move in such a way that losses on the
first exposed position should be offset by gains on the second currency exposure and vice versa.
a) forward contract
b) exposure netting
c) money-market hedge
d) currency option
Ans: b
Section: Exposure netting
Level: Easy
MEDIUM (applied)
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10.12 The major difference between the temporal method and the monetary/nonmonetary
method is that
a) under the monetary/nonmonetary method, long-term debt is translated at the historical rate,
whereas under the temporal method, long-term debt is translated at the current rate
b) under the monetary/nonmonetary method, inventory is always translated at the historical rate,
whereas under the temporal method, inventory may be translated at the current rate if the
inventory is shown on the balance sheet at market values
c) under the monetary/nonmonetary method, fixed assets are translated at the historical rate,
whereas under the temporal method, fixed assets may be translated at the current rate
d) under the monetary/nonmonetary method, accounts receivable are always translated at the
historical rate, whereas under the temporal method, receivables may be translated at the current
rate
Ans: b
Section: Alternative currency translation methods
Level: Medium
10.13 ____________ exposure results from the possibility of incurring a gain or loss related to a
sale or purchase already entered into and denominated in another currency.
a) translation
b) transaction
c) operating
d) accounting
Ans: b
Section: Transaction exposure
Level: Medium
10.14 It is possible for transaction exposure to be positive and translation exposure in the same
currency to be
a) always positive
b) exactly offsetting
c) negative
d) synonymous
Ans: c
Section: Transaction exposure
Level: Medium
10.15 Which one of the following would NOT be a suggested element for an effective exposure
management strategy?
a) determine the types of exposure to be monitored
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b) formulate corporate objectives

c) ensure that the corporate objectives a consistent with maximizing shareholder value
d) avoid the use of forward contracts where possible
Ans: d
Level: Medium
The following information is to be used in answering questions 16- 17.
In 1995, Ajax Manufacturing's German subsidiary has the following balance sheet:
Cash, marketable
securities
Accounts receivable
Inventory (at market.
Fixed Assets
DM 250,000
1,000,000
2,700,000
5,100,000
----------------DM 9,050,000
Current liabilities
Long-term debt
Equity
DM 750,000
3,400,000
4,900,000
Total liabilities
plus equity
--------------DM 9,050,000
Total assets
Suppose the DM appreciates from $0.70 to $0.76 during the period.
10.16 Under the current/noncurrent method, what is Ajax's translation gain (loss).?
a) a gain of $294,000
b) a gain of $192,000
c) a loss of $174,000
d) a loss of $12,000
Ans: b
Section: Current/non current method
Level: Medium
10.17 Under the temporal method, what is Ajax's translation gain (loss).?
a) a gain of $294,000
b) a gain of $192,000
c) a loss of $174,000
Ans: d
Section: Temporal method
Level: Medium
10.18 Under the current rate method, what is Ajax's translation gain (loss).?
4-23
a)
b)
c)
d)
Test Bank
a gain of $294,000
a gain of $192,000
a loss of $174,000
a loss of $12,000
Ans: a
Section: Current rate method
Level: Medium
10.19 Under the monetary/non-monetary method, what is Ajax's translation gain (loss)?
a) a gain of $294,000
b) a gain of $192,000
c) a loss of $174,000
Ans: c
Section: Monetary/non-monetary method
Level: Medium
10.20 Which of the following is a basic hedging technique during depreciation?
a) buy local currency forward
b) sell a local currency put option
c) reduce levels of local currency cash and marketable securities
d) loosen credit (increase local currency receivables)
Ans: c
Section: Costs and benefits of standard hedging techniques
Level: Medium
10.21 Dell Computer has a 1 million receivable that it expects to collect in one year. Suppose
the interest rate on pounds is 15%. How could Dell protect this receivable using a money market
hedge?
a) borrow 1 million pounds today
b) lend 1 million pounds today
c) borrow 869,565 pounds today
d) lend 986,754 pounds today
Ans: c
Section: Basic hedging techniques
Level: Medium
4-24
Test Bank
10.22 Suppose markets are efficient, there are no taxes, and relative prices remain constant. In
such a world,
a) hedging cannot still be of value.
b) exchange risk management remains of vital concern.
c) markets are always free of inflation.
d) exchange risk is nonexistent.
Ans: b
Section: Managing risk management
Level: Medium
10.23 American Airlines hedges a 2.5 million receivable by selling pounds forward. If the spot
rate is 1 = $1.73 and the 90-day forward rate is $1.7158, what is American's cost of hedging?
a) $142,000
b) $35,500
c) $8,875
d) it is unknown at the time American enters into its hedge
Ans: d
Section: The true cost of hedging
Level: Medium
10.24 Suppose it is 1987 and General Motors uses a money market hedge to protect a Lit 200
million payable due in one year. The U.S. interest rate at the time of the hedge was 9% and the
lira interest rate was 14%. If the spot rate moved from Lit 1293 at the start of the year to Lit 1349
at the end of the year, what was GM's cost of the money market hedge?
a) $3,647
b) $414
c) GM gained $1,069
d) GM gained $5,631
Ans: b
Level: Medium
10.25 Suppose PepsiCo hedges a 1 billion dividend it expects to receive from its Japanese
subsidiary in 90 days with a forward contract. The current spot rate is 150/$1 and the 90-day
forward rate is 149/$1. If the spot rate in 90 days is 154/$, how much has this forward market
hedge cost PepsiCo?
a) $173,160
b) $44,743
c) Pepsi gains $173,160 from the forward contract
d) Pepsi gains $217,903 from the forward contract
4-25
Test Bank
Ans: d
Level: Medium
DIFFICULT (applied)
10.26 Suppose the English subsidiary of a U.S. firm had current assets of 1 million, fixed
assets of 2 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
Ans: d
Section: Application of FASB No. 52
Level: Difficult
10.27 Suppose the German subsidiary of a U.S. firm had current assets of 3 million, fixed
assets of 6 million and current liabilities of 3 million both at the start and at the end of the
year. There are no long-term liabilities. If the euro depreciated during that year from $.48 to $.38,
the FASB-52 translation gain (loss. to be included in the parent company's equity account is
a) 0, since the current assets and current liabilities cancel
b) +$300,000
c) -$350,000
d) -$600,000
Ans: d
Level: Difficult
10.28 Transaction gains and losses that result from adjusting assets and liabilities denominated
in a currency other than the functional currency must appear on the foreign unit's income
statement unless the gains or losses are attributable to
a) foreign currency transactions that are designated as an economic hedge of a net investment in
a foreign entity
b) intercompany foreign-currency transactions that are of a short- term nature
c) foreign-currency transactions that involve currency speculation
d) the prospect of government intervention using currency controls
4-26
Test Bank
Ans: a
Level: Difficult
10.29 If you fear the dollar will rise against the Spanish peseta, with a resulting adverse change
in the dollar value of the equity of your Spanish subsidiary, you can hedge by
a) selling pesetas forward in the amount of net assets
b) buying pesetas forward in the amount of net assets
c) reducing the liabilities of the subsidiary
d) selling pesetas forward in the amount of total assets
Ans: a
Section: Forward market hedge
Level: Difficult
10.30 On March 1, 1998, Bechtel submits a franc-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 franc amount of the bid forward for U.S. dollars
b) buy French francs forward in the amount of the contract
c) buy a put option on francs in the amount of the franc exposure
d) sell a call option on francs in the amount of franc exposure
Ans: c
Section: Foreign currency options
Level: Difficult
10.31 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
Ans: d
Section: Cross-hedging
Level: Difficult
10.32 If you fear the dollar will rise against the French euro, with a resulting adverse change in
the dollar value of the equity of your French subsidiary, you can hedge by
4-27
a)
b)
c)
d)
Test Bank
selling euros forward in the amount of net assets

buying euros forward in the amount of net assets
reducing the liabilities of the subsidiary
selling euros forward in the amount of total assets
Ans: a
Level: Difficult
10.33 Suppose that the spot rate and the 90-day forward rate on the pound sterling are $1.35 and
$1.30, respectively. Your company, wishing to avoid foreign exchange risk, sells 500,000
forward 90 days. Assuming that the spot rate remains the same 90 days hence, your company
would
a) receive 500,000 90 days hence
b) receive more than 500,000 in 90 days
c) have been better off not to have sold pounds forward
d) receive nothing
Ans: c
Level: Difficult
10.34 In 1993, Ford simultaneously borrows Spanish pesetas at 13% and invests dollars at 10%,
both for one year. At the time Ford enters into these transactions, the spot rate for the peseta is
$0.095. If the spot rate is peseta 1 = $0.087 in one year, what is the cost to Ford of this money
market hedge?
a) 2.0%
b) 3.8%
c) 1.3%
d) Ford has a 6.5% gain, not a cost
Ans: d
Section: Money market hedge
Level: Difficult
10.35 Du Pont has entered into a currency risk sharing arrangement with British Gas. Under the
contract, Du Pont agrees to pay British Gas a base price of $10 million for gas purchases, but the
parties would share the currency risk equally beyond a neutral zone, specified as a band of
exchange rates: $1.67-1.73:1. Within the neutral zone, Du Pont must pay BG the pound
equivalent of $10 million at the base rate of $1.70. Suppose the spot rate at the time of payment
is 1 = $1.63. How much will Du Pont owe British Gas?
a) $10 million
b) $9,702,381
4-28
Test Bank
c) $9,588,235
d) $9,819,277
Ans: b
Section: Currency risk sharing
Level: Difficult
The following information is to be used in answering questions 36-38.
U.S. borrowing rate for 1 year
= 9.5%
U.S. deposit rate for 1 year
= 8.7%
French borrowing rate for 1 year
= 11.3%
French deposit rate for 1 year = 10.2%
French franc spot quote
= $0.1763-78
French franc 1-year forward quote = $0.1729-47
10.36 What value can Alcoa lock in for a receivable of FF 3 million due in one year if it
executes a money market hedge today?
a) $525,540
b) $516,545
c) $530,012
d) $520,940
Ans: b
Level: Difficult
10.37 What value can Alcoa lock in for its FF 3 million receivable if it executes a forward
contract today?
a) $518,700
b) $524,100
c) $528,900
d) $532,410
Ans: a
Level: Difficult
10.38 Suppose Alcoa in 1995 had a payable of FF 1 million due in one year. Alcoa's cost of the
payable using a money market hedge is _______ and its cost using a forward market hedge is
_______.
a) $173,900; $177,470
4-29
Test Bank
b) $174,925; $176,300
c) $176,671; $172,900
d) $178,937; $174,700
Ans: d
Level: Difficult
10.39 In 1990, Goodyear had operations in both Germany and the Netherlands. In the past the
Dutch guilder and Deutsche mark were highly correlated in their movements against the U.S.
dollar. If the Dutch unit has net inflows of guilders and the German unit has net inflows of DM,
then Goodyear's combined transaction exposure
a) approximately equals the sum of its guilder and DM exposures
b) is less than the sum of its guilder and DM exposures because the currencies are highly
correlated
c) is less than the sum of its guilder and DM exposures because of diversification between the
companys subsidiaries
d) is not significant due to the highly correlated nature of the two currencies
Ans: a
Section: Cross-hedging
Level: Difficult
10.40 In 1996, DEC hedges a FF 3.2 million receivable due in 180 days. The current spot rate is
FF 1 = $0.18834 and the 180-day forward rate is FF 1 = $0.18625. If the spot rate at the end of
180 days is $0.18728, how much has the forward market hedge cost DEC?
a) $6,688
b) $3,392
c) $3,296
d) DEC gains $6,688 on the hedge
Ans: c
Level: Difficult
CHAPTER 11
Measuring and Managing Economic Exposure
4-30
Test Bank
EASY (definitional)
11.1 During a home currency appreciation, exporters may pull out of markets that foreign
competition makes ________.
a) unprofitable
b) more competitive
c) profitable
d) more liquid
Ans: a
Section: Foreign exchange risk and economic exposure
Level: Easy
11.2 Economic exposure is based on the extent to which the ______ of the firm will change
when exchange rates change.
a) value
b) current assets
c) long-term liabilities
d) competitive advantages
Ans: a
Level: Easy
11.3 _______ exposure arises because currency fluctuations can alter a companys future
revenues and expenses.
a) transaction
b) operating
c) political
d) translation
Ans: b
Level: Easy
11.4 With respect to home currency (HC) appreciation, the key issue for a domestic firm is its
degree of ______.
a) market share
b) product differentiation
c) marketing plan
d) pricing flexibility
4-31
Test Bank
Ans: d
Source: Operating exposure
Level: Easy
11.5 In the face of exchange rate volatility, developing a pricing strategy must address two key
issues:
a) market selection and segmentation
b) market share and the work force
c) market share and profit margin
d) market share and segmentation
Ans: c
Section: Pricing strategy
Level: Easy
11.6 The _______ the price elasticity of demand, the _____ the incentive to hold down price and
thereby expand sales.
a) lower, greater
b) lower, lower
c) greater, lower
d) greater, greater
Ans: d
Section: Operating exposure
Level: Easy
11.7 During periods of exchange rate volatility, firms dealing in _______ products face more
exchange rate risk that the firms selling _________ products.
a) low demand, high demand
b) low supply, high supply
c) undifferentiated, differentiated
d) differentiated, undifferentiated
Ans: c
Level: Easy
11.8 With respect to production management of exchange risk, ________ and plant location are
the principal variables that companies may change to manage the risk.
a) product innovation
b) product retirement
c) market selection
4-32
Test Bank
d) product sourcing
Ans: a
Section: Product strategy
Level: Easy
11.9 One way an MNC may improve productivity in the face of exchange rate volatility is by
revising ________.
a) product offerings
b) the input mix
c) and shifting production between plants
d) the promotional strategy
Ans: a
Level: Easy
11.10 The greatest boost to a firms competitiveness comes from compressing the time it takes
to bring new and improved products to market also known as _________.
a) product innovation
b) the product cycle
c) input mix
d) market segmentation
Ans: b
Section: Planning for exchange rate changes
Level: Easy
11.11 While the strategic marketing and production adjustments occur over the long run,
financial management may finance the firms operations such that shortfalls in cash flows during
the adjustments are offset by a reduction in __________ expenses.
a) marketing
b) production
c) debt-servicing
d) hedging
Ans: c
Section: Financial management of exchange rate risk
Level: Easy
MEDIUM (applied)
4-33
Test Bank
11.12 A weak dollar will

a) force American exporters to raise their foreign currency prices
b) enable American importers to reduce their dollar costs
c) enable American exporters to improve their profit margins
d) cost American exporters market share abroad
Ans: c
Section: Real exchange rate changes and exchange rate risk
Level: Medium
11.13 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
Ans: a
Level: Medium
11.14 Which one of the following would NOT be an appropriate response for a U.S. exporter to
appreciation of the dollar?
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) lower the foreign currency price if demand is inelastic for the product
Ans: d
Level: Medium
11.15 Which one of the following areas is NOT a way companies often respond to exchange
rate risk when they alter their product strategy?
a) shifting the firms manufacturing base to another country
b) the timing of new-product introduction
c) changing the size of its product line
d) product innovation with advanced technology
4-34
Test Bank
Ans: a
Level: Medium
11.16 Which of the following strategies assumes that the MNC has already collected a portfolio
of different facilities world wide?
a) production shifting
b) product innovation
c) product sourcing
d) raising productivity
Ans: a
Section: Shifting production among plants
Level: Medium
11.17 When we examine operating exposure, the key issue for a domestic firm is its
a) prior import competition
b) pricing flexibility
c) asset valuation adjustment
d) low import content
Ans: b
Level: Medium
DIFFICULT (applied)
11.18 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) it priced its cars in deutschemarks
Ans: a
Section: Financial management of exchange rate risk
Level: Difficult
11.19 A company producing a differentiated 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.
4-35
a)
b)
c)
d)
Test Bank
high, low
low, low
low, high
high, high
Ans: c
Level: Difficult
11.20 The appropriate response for a U.S. exporter to depreciation of the dollar would be to
a) raise the foreign currency price if the dollar depreciation was expected to be temporary and
the cost of losing market share was minimal
b) move some production offshore if the depreciation were expected to persist for an extended
period
c) lower the foreign currency price constant if demand is quite inelastic
d) set up a netting center in the home country
Ans: a
Section: Characteristic economic effects of exchange rate changes
Level: Difficult
11.21 Suppose McDonald's charges Ptas. 25 for a burger in Madrid. Its costs are Ptas. 18 per
burger and these costs are not expected to change with the exchange rate. If the peseta devalues
from $0.107 to $0.096, what price will McDonald's have to charge for its burgers to maintain its
dollar profit margin?
a) Ptas. 25.80
b) Ptas. 27.86
c) Ptas. 22.43
d) Ptas. 24
Ans: a
Section: Calculating economic exposure
Level: Difficult
11.22 Suppose Apple is selling Macintosh computers in 1996 in Germany for DM 5,500 when
the exchange rate is DM 1 = $0.68. If the DM rises to $0.71, what price must Apple charge to
maintain its dollar unit revenue?
a) DM 5,147
b) DM 6,361
c) DM 5,743
d) DM 5,268
Ans: d
4-36
Test Bank
Section: Calculating economic exposure

Level: Difficult
11.23 Following a devaluation of the Greek drachma, which of the following products sold in
Greece is most likely to bear a drachma 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
Ans: c
Level: Difficult
11.24 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
Ans: d
Level: Difficult
11.25 A U.S. exporter that anticipates an appreciation of the dollar should
a) sell foreign currencies forward
b) borrow foreign currencies
c) scout out possible foreign production sites
d) consider raising dollar prices on exports
Ans: c
Section: Planning for exchange rate risk
Level: Difficult
11.26 Which of the following products is most likely to benefit from depreciation of the U.S.
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 tools
4-37
Test Bank
Ans: b
Level: Difficult
11.27 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
Ans: a
Level: Difficult
11.28 Which one of the following would not be an improvement from shorter product cycles to
improve currency risk management? It would allow 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) increase the average price elasticity of demand
Ans: d
Section: The economic consequences of exchange rate changes
Level: Difficult
11.29 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.
Ans: b
Level: Difficult
4-38
Test Bank
11.30 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
Ans: c
Level: Difficult
4-39

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Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

c) Unbiased forward rate

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

c) Subsidized by the International Monetary Fund

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Exchange rate per $

An arbitrage profit can be obtained by

Shapiros Multinational Financial Management, 9th Edition

borrowing pounds and lending dollars

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

8.19 You can speculate on an appreciation of the Japanese yen by

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

d) cash flows to currency movements

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

b) formulate corporate objectives

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

selling euros forward in the amount of net assets

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

11.12 A weak dollar will

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

Section: Calculating economic exposure

b) Chevrolet automobile with a highly price elastic demand

Shapiros Multinational Financial Management, 9th Edition

Shapiros Multinational Financial Management, 9th Edition

c) raise dollars in the U.S. to hedge against currency risk

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