Chapter 12

    Managing Economic Exposure and

    Translation Exposure

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

     ANSWER: B

    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

     ANSWER: B

    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

     ANSWER: D

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Chapter 12: Managing Economic Exposure and Translation Exposure 535

    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

     D) increase; high

     ANSWER: D

5. Which of the following is an example of economic exposure but not an example of transaction

    exposure?

     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.

     ANSWER: A

    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) Both of these are true.

     D) Neither of these is true.

     ANSWER: D

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

     ANSWER: D

    536 International Financial Management 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

     ANSWER: D

    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) none of these

     ANSWER: C

    10. It is generally least difficult to effectively hedge various types of:

     A) translation exposure.

     B) transaction exposure.

     C) economic exposure.

     D) translation exposure AND economic exposure.

     ANSWER: B

11. With regard to hedging translation exposure, translation losses _______; and gains on forward

    contracts used to hedge translation exposure _______.

     A) are not tax deductible; are taxed

     B) are tax deductible; are taxed

     C) are not tax deductible; are not taxed

     D) are tax deductible; are not taxed

     ANSWER: A

12. If a firm is subject to _______, then it must be subject to translation exposure.

     A) transaction exposure

     B) economic exposure

     C) transaction exposure AND economic exposure

     D) none of these

     ANSWER: D

Chapter 12: Managing Economic Exposure and Translation Exposure 537

    13. If the Singapore dollar appreciates against the U.S. dollar over this year, the consolidated earnings

    of a U.S. company with a subsidiary in Singapore will be _______ as a result of the exchange rate

    movement.

     A) negative

     B) adversely affected

     C) favorably affected

     D) unaffected

     ANSWER: C

    14. Assume a U.S. firm uses a forward contract to hedge all of its translation exposure. Also assume

    that the firm underestimated what its foreign earnings would be. Assume that the foreign currency

    depreciated over the year. The firm would generate a translation _______, which would be _______

    than the gain generated by the forward contract.

     A) loss; smaller

     B) loss; larger

     C) gain; larger

     D) gain; smaller

     ANSWER: B

    15. A perfect hedge (full coverage) on translation exposure can usually be achieved when:

     A) using the money market hedge.

     B) using the forward hedge.

     C) using the futures hedge.

     D) none of these, since a perfect hedge is nearly impossible.

     ANSWER: D

    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.

     ANSWER: B

    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.

538 International Financial Management

    ANSWER: B

    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 these firms are exposed to translation exposure.

ANSWER: D

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 these

ANSWER: B

20. An effective way for an MNC to assess its economic exposure is to look at the firm’s:

    A) income statement.

    B) liquidity.

    C) retained earnings.

    D) level of stockholder’s equity.

ANSWER: A

    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 these.

ANSWER: C

22. Managing economic exposure is generally perceived to be _______ managing transaction exposure.

    A) more difficult

    B) less difficult

    C) just as difficult as

    D) none of these

ANSWER: A

    Chapter 12: Managing Economic Exposure and Translation Exposure 539

    23. As opposed to transaction exposure, managing economic exposure involves developing a _______ solution.

    A) short-term

    B) long-term

    C) immediate

    D) none of these

ANSWER: B

    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) none of these

ANSWER: A

    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.

ANSWER: B

    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

    B) more; more

    C) less; fewer

    D) less; more

ANSWER: C

    27. An MNC expects to sell fixed assets it utilizes in Europe in the distant future. In order to hedge the sale of these assets in the distant future, the MNC could create a(n) _______ that _______ the expected value of the assets in the future.

    A) asset; matches

    B) asset; exceeds

    C) liability; matches

    D) liability; is less than

ANSWER: C

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28. Long-term forward contracts are a possible way to hedge the distant sale of fixed assets in foreign

    countries, but they may not be available for many emerging market currencies.

    A) true.

    B) false.

    ANSWER: A

    29. _______ exposure occurs when an MNC translates each subsidiary’s financial data to its home

    currency for consolidated financial statements.

    A) Translation

    B) Transaction

    C) Economic

    D) None of these

    ANSWER: A

30. _______ is not a limitation of hedging translation exposure.

    A) Inaccurate stock price forecasts

    B) Inadequate forward contracts for some currencies

    C) Accounting distortions

    D) Increased transaction exposure

    ANSWER: A

    31. To hedge translation exposure, MNCs could _______ that their foreign subsidiaries receive as

    earnings to create a cash outflow in the currency to offset the earnings received in that currency.

    A) purchase the currency forward

    B) sell the currency forward

    C) purchase futures contracts of the currency

    D) purchase the currency forward OR purchase futures contracts of the currency

    E) none of these

    ANSWER: B

    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

    ANSWER: D

33. In general, it is more difficult to effectively hedge economic or translation exposure than to hedge

    transaction exposure.

    A) true.

    B) false.

Chapter 12: Managing Economic Exposure and Translation Exposure 541

    ANSWER: A

    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.

    ANSWER: B

    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.

    ANSWER: B

    36. Hedging translation exposure with forward contracts can backfire if the currency being hedged

    depreciates.

    A) true.

    B) false.

    ANSWER: A

    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.

    ANSWER: A

    38. The translation gain (or loss) is simply a paper gain (or loss). Conversely, the gain (or loss)

    resulting from a hedge strategy is a real gain (or loss).

    A) true.

    B) false.

    ANSWER: A

39. All MNCs are subject to translation exposure.

    A) true.

    B) false.

    ANSWER: B

    40. U.S.-based MNCs invoicing in Asian currencies and incurring expenses in Asian currencies were

    probably less affected by 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.

542 International Financial Management

    ANSWER: A

    41. The management of economic exposure is normally focused completely on transactions that will

    occur in the next three months.

    A) true.

    B) false.

    ANSWER: B

    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.

    ANSWER: B

    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.

    ANSWER: A