FIN 435 Lecture Notes - Lecture 7: Spot Contract, Money Market, Forward Market

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magentaporpoise298

9 Nov 2016

School

Old Dominion University

Department

Finance

Course

FIN 435

Professor

Bruce Seifert

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Document Summary

Understand transaction risk: definition of transaction risk, how to hedge a receivable, how to hedge a payable, picking the best alternative, should a firm hedge. Measures changes in the value of outstanding financial obligations incurred prior to a change in exchange rates but not due to be settled until after an exchange rate change. Buying or selling goods and services on credit whose prices are stated in a foreign currency. Borrowing or lending in a foreign currency. Being a party to an underperformed foreign exchange forward contract. Acquiring other assets or incurring other liabilities denominated in a foreign currency. Exporter sells an item for 40,000 pounds and expects exchange rate to be $ Risk is that the exporter will receive more or less than $ 80,000. Note if exporter invoices in home currency the exporter avoids transaction risk. In this case risk is transferred to the importer.

Related Questions

1. Which of the following statements about Multinational financial management is FALSE:

a. The effects of changing currency values must be included in financial analyses.

b. Legal and economic differences must be considered in financial decisions.

c. Political risk must be included from multinational corporate financial analyses.

d. It is illegal and discriminatory to consider cultural differences when considering firm goals and employee management.

2. ______________ occurs if a firm has assets or liabilities in foreign countries.

a) Translation Exposure

b) Transaction Exposure

c) Economic Exposure

d) Political Exposure

3. _______________ says that the ratio of forward exchange rates to spot exchange rates must also equal the ratio of nominal risk free rates.

a) Fisher Effect

b) Interest Rate Parity

c) Purchasing Power Parity

d) Inflation Parity

4. Which statement is FALSE?

a The United States has a large current account deficit in its balance of payments

b A Eurodollar is a US dollar deposited in a bank outside of the US

c American Depository Receipts represent ownership of stock of foreign companies

d An Interest Rate Swap is when banks lend to each other

5. In the currency markets, 1 U.S. dollar = 0.6 British pound and 1 U.S. dollar equals 1.1 euros. Wolverine Cola produces cherry cola in England at a cost of 0.55 British pound per unit. The product is sold in France for 1.25 euros. In terms of U.S. dollars, how much profit is Wolverine realizing on each unit sold?

a. $0.78 b. $0.46 c. $0.35 d. $0.11

blushjellyfish481

Question: As a manager of a U.S. domestic company, you are c...

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As a manager of a U.S. domestic company, you are concerned about foreign currency exposure of your firmâs sales to the United Kingdom. You currently export $10 million of products to the United Kingdom annually and receive payment in pounds sterling. You send two large shipments each year valued at $5 million each. The invoice carriers net 90-day terms. Thus, from the invoice date, your company is exposed to currency exchange risk for a period of 90 days.

You are considering the possibility of using futures, options, or futures options as possible hedging tools. Your broker recently sent you the following data on the various hedging contracts available for your June 1 invoice with payments due September 1.

Current exchange rate (June 1) $1.67 per pound

Assumed spot exchange rate on September 1 is $2.00

$90-day forward rate as of June 1: $1.65

Options (31,250)
Striking price	June 1, September Call Premium	Call Premium September 1
165.0	4.35	35.00
170.0	2.40	30.00
175	1.20	25.00
Future options (62,500)
Striking price	June 1, September Call Premium	Call Premium September 1
1650	4.12	33.00
1700	2.20	27.00
1750	1.06	22.00
Future (62,500)
	June 1 Settle	September 1 Settle
September	1.6496	2.055

a. Assume you donât hedge. Calculate the dollar loss occurring from the change in exchange rates from June 1 to September 1.

b. Assume you hedge with an options contract. Calculate the net result from the change in the exchange rates from June 1 to September 1. Assume commission fees equal $60.

c. Assume you hedge with a futures option contract. Calculate the net result from the change in the exchange rate from June 1 to September 1. Assume commission fees equal $60.

d. Assume you hedge with a futures contract. Calculate the net result from the hedge assuming that the margin for one contract is $1,000 and roundtrip commission fees equal $60.

e. Assume you enter into a 90-day forward rate agreement. Calculate the net result from the hedge assuming that the fee for the agreement is $150.

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8. Which of the following would require a higher return under a risk-adjusted return on capital (RAROC) approach to capital allocation?

a)traditional commercial lending activities

b)government securities

c) home mortgages

d) 2 and 3.

9. Trend analysis often involves

a) comparison of past firm performance to current industry performance

b)averaging past years' performance to remove the effects of accounting changes

c) graphically portraying performance measures over time

d) all of the above

e) 1 and 3

10. Transaction risk is the risk of a loss _______ and translation risk is the risk of a loss _______

a) in the value of a firmâs equity with assets denominated in one currency and liabilities in another; with changes in exchange rates for foreign transactions

b) with changes in exchange rates for foreign transactions; in the value of a firmâs equity with assets denominated in one currency and liabilities in another

c) in the value of a firmâs assets with equity denominated in one currency and liabilities in another; with changes in exchange rates for foreign transactions

d) none of the above

11. The special-purpose vehicle (SPV)

a) allows sales accounting treatment of under generally accepted accounting principles (GAAP)

b) usually reduces the credit rating of the structured securitization

c) monitors reports by the loan servicer on the pool performance

d) all of the above

12. The major financing source for a bank comes from

a) loans

b) deposits

c) equity

d) none of the above

13. The provision for loan losses would likely be

a) increased during economic downturns

b) decreased during economic downturns

c) increased during an economic expansion

d) none of the above

e) 2 and 3

14. The Internet

a) may allow banks to cross-sell products, reduce transaction costs, and improve market presence, service, and quality provided to customers

b) may make customers more loyal to the bank by increasing the convenience and access to a broad variety of services, thereby reducing the probability of customersâ switching institutions

c) has increased costs for financial institutions due to lack of economies of scale

d) 1 and 2

15. Pillar 2 of Basel II

a) includes capital charges for credit risk on a case-by-case basis

b) is mutually enforced by Pillars 1 and 3

c) provides for supervisory review of banks internal assessments of capital allocation and adequacy

d) all of the above

e) 2 and 3

16. Types of loan sales include

a) the novation, which transfers all rights and obligations of the selling bank to the buyer

b) the assignment, which gives the buyer the right to take action against the borrower if payments are not made

c) the participation, in which the bank continues to service the loan

d) all of the above

17. The difference between the book value of capital and the market value of capital for the same institution is influenced by

a) changes in interest rates

b) changes in reserve requirements

c) changes in historic asset costs

d) none of the above

e) all of the above

18. Financial institutions are required to maintain liquid assets for the purpose(s) of

a) meeting repayment obligations to customers holding maturing liabilities

b) meeting repayment obligations to customers holding maturing liabilities. meeting regulatory requirements for reserves

c) meeting the dividend payment requirements of outstanding common stock

d) all of the above

e) 1 and 2

19. The process of securitization typically involves

a) removing loans from a bank's balance sheet and selling them to investors

b) bank origination of loans.

c) an insurance company surety bond or a bank letter of credit

d) all of the above

20. Generally, as the maturity of an asset or liability rises it has a higher risk premium due to greater maturity risk and greater

a) default risk

b) default risk

c) liquidity risk

d) all of the above

e) 2 and 3

FIN 435 Lecture Notes - Lecture 7: Spot Contract, Money Market, Forward Market

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