Chapter 10 Transaction and Translation Exposure Multiple Choice and True/False Questions 10.1 Types of Foreign Exchange Exposure

Fundamentals of Multinational Finance, 4e (Moffett)
Chapter 10 Transaction and Translation Exposure
Multiple Choice and True/False Questions
10.1 Types of Foreign Exchange Exposure
1) ________ exposure deals with cash flows that result from existing contractual obligations.
A) Operating
B) Transaction
C) Translation
D) Economic
Answer: B
Diff: 1
Topic: 10.1 Types of Foreign Exchange Exposure
Skill: Recognition
2) ________ exposure measures the change in the present value of the firm resulting from unexpected
changes in exchange rates.
A) Operating
B) Transaction
C) Translation
D) Accounting
Answer: A
Diff: 1
Skill: Recognition
3) Each of the following is another name for operating exposure EXCEPT ________.
A) economic exposure
B) strategic exposure
C) accounting exposure
D) competitive exposure
Answer: C
Diff: 1
Skill: Recognition
1
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4) Transaction exposure and operating exposure exist because of unexpected changes in future cash
flows. The difference between the two is that ________ exposure deals with cash flows already
contracted for, while ________ exposure deals with future cash flows that might change because of
changes in exchange rates.
A) transaction; operating
B) operating; transaction
C) operating; accounting
D) none of the above
Answer: A
Diff: 1
Skill: Recognition
5) ________ exposure is the potential for accounting-derived changes in owner's equity to occur because
of the need to translate foreign currency financial statements into a single reporting currency.
A) Transaction
B) Operating
C) Economic
D) Accounting
Answer: D
Diff: 1
Skill: Recognition
6) Losses from ________ exposure generally reduce taxable income in the year they are realized.
________ exposure losses may reduce taxes over a series of years.
A) accounting; Operating
B) operating; Transaction
C) transaction; Operating
D) transaction; Accounting
Answer: C
Diff: 1
Skill: Recognition
7) Losses from ________ exposure generally reduce taxable income in the year they are realized.
________ exposure losses are not cash losses and therefore, are not tax deductible.
A) transaction; Operating
B) accounting; Operating
C) accounting; Transaction
D) transaction; Translation
Answer: D
Diff: 1
Skill: Recognition
2
8) MNE cash flows may be sensitive to changes in which of the following?
A) exchange rates
B) interest rates
C) commodity prices
D) all of the above
Answer: D
Diff: 1
Skill: Recognition
10.2 Why Hedge?
1) ________ is a technique used by MNEs to deal with currency exposure.

A) No counter-measure
B) Speculation
C) Hedging
D) All are techniques MNEs could use.
Answer: D
Diff: 1
Topic: 10.2 Why Hedge?
Skill: Recognition
2) Hedging, or reducing risk, is the same as adding value or return to the firm.
Answer: FALSE
Diff: 1
Skill: Conceptual
3) Assuming no transaction costs (i.e., hedging is "free"), hedging currency exposures should ________
the variability of expected cash flows to a firm and at the same time, the expected value of the cash
flows should ________.
A) increase; not change
B) decrease; not change
C) not change; increase
D) not change; not change
Answer: B
Diff: 1
Skill: Conceptual
3
4) Which of the following is NOT cited as a good reason for hedging currency exposures?
A) Reduced risk of future cash flows is a good planning tool.
B) Reduced risk of future cash flows reduces the probability that the firm may not meet required cash
flows.
C) Currency risk management increases the expected cash flows to the firm.
D) Management is in a better position to assess firm currency risk than individual investors.
Answer: C
Diff: 1
Skill: Recognition
5) There is considerable question among investors and managers about whether hedging is a good and
necessary tool.
Answer: TRUE
Diff: 1
Skill: Recognition
6) Which of the following is cited as a good reason for NOT hedging currency exposures?
A) Shareholders are more capable of diversifying risk than management.
B) Currency risk management through hedging does not increase expected cash flows.
C) Hedging activities are often of greater benefit to management than to shareholders.
D) All of the above are cited as reasons NOT to hedge.
Answer: D
Diff: 1
Skill: Recognition
7) The key arguments in opposition to currency hedging such as market efficiency, agency theory, and
diversification do not have financial theory at their core.
Answer: FALSE
Diff: 1
Skill: Conceptual
8) ________ exposure may result from a firm having a payable in a foreign currency.
A) Transaction
B) Accounting
C) Operating
D) None of the above
Answer: A
Diff: 1
Skill: Conceptual
4
10.3 Trident's Transaction Exposure
1) A U.S. firm sells merchandise today to a British company for £100,000. The current exchange rate is
$2.03/£ , the account is payable in three months, and the firm chooses to avoid any hedging techniques
designed to reduce or eliminate the risk of changes in the exchange rate. The U.S. firm is at risk today of
a loss if
A) the exchange rate changes to $2.00/£.
B) the exchange rate changes to $2.05/£.
C) the exchange rate doesn't change.
D) all of the above.
Answer: D
Diff: 1
Topic: 10.3 Trident's Transaction Exposure
Skill: Analytical
designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to
$2.05/£ the U.S. firm will realize a ________ of ________.
A) loss; $2000
B) gain; $2000
C) loss; £2000
D) gain; £2000
Answer: B
Diff: 2
Skill: Analytical
designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to
$2.01/£ the U.S. firm will realize a ________ of ________.
A) loss; $2,000
B) gain; $2,000
C) loss; £2000
D) gain; £2000
Answer: A
Diff: 2
Skill: Analytical
5
4) ________ is NOT a popular contractual hedge against foreign exchange transaction exposure.
A) Forward market hedge
B) Money market hedge
C) Options market hedge
D) All of the above are contractual hedges.
Answer: D
Diff: 1
Skill: Recognition
Instruction 10.1:
Use the information for the following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a
German firm, for euro 1,250,000. The sale was made in June with payment due six months later in
December. Because this is a sizable contract for the firm and because the contract is in euros rather than
dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising
from the sale. To help the firm make a hedging decision you have gathered the following information.
∙ The spot exchange rate is $1.40/euro

∙ The six month forward rate is $1.38/euro
∙ Plains States' cost of capital is 11%
∙ The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
∙ The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
∙ The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
∙ The U.S. 6-month lending rate is 6% (or 3% for 6 months)
∙ December put options for euro 625,000; strike price $1.42, premium price is 1.5%
∙ Plains States' forecast for 6-month spot rates is $1.43/euro
∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
5) Refer to Instruction 10.1. If Plains States chooses not to hedge their euro receivable, the amount they
receive in six months will be ________.
A) $1,750,000
B) $1,250,000
C) $892,857
D) undeterminable today
Answer: D
Diff: 2
Skill: Analytical
6
6) Refer to Instruction 10.1. If Plains States chooses to hedge its transaction exposure in the forward
market, it will ________ euro 1,250,000 forward at a rate of ________.
A) sell; $1.38/euro
B) sell; $1.40/euro
C) buy; $1.38/euro
D) buy; $1.40/euro
Answer: A
Diff: 2
Skill: Analytical
7) Refer to Instruction 10.1. Plains States chooses to hedge its transaction exposure in the forward
market at the available forward rate. The payoff in 6 months will be ________.
A) $1,750,000
B) $1,250,000
C) $1,725,000
D) $1,787,500
Answer: C
Diff: 2
Skill: Analytical
8) Refer to Instruction 10.1. If Plains States locks in the forward hedge at $1.38/euro, and the spot rate
when the transaction was recorded on the books was $1.40/euro, this will result in a "foreign exchange
loss" accounting transaction of ________.
A) $0
B) $25,000
C) This was not a loss; it was a gain of $25,000.
D) There is not enough information to answer this question.
Answer: B
Diff: 2
Skill: Analytical
9) Refer to Instruction 10.1. Plains States would be ________ by an amount equal to ________ with a
forward hedge than if they had not hedged and their predicted exchange rate for 6 months had been
correct.
A) better off; $43,750
B) better off; $62,500
C) worse off; $43,750
D) worse off; $62,500
Answer: D
Diff: 2
Skill: Analytical
7
10) Refer to Instruction 10.1. Plains States could hedge the Euro receivables in the money market. Using
the information provided, how much would the money market hedge return in six months assuming
Plains States reinvests the proceeds at the U.S. investment rate?
A) $1,250,000
B) $1,724,880
C) $1,674,641
D) $1,207,371
Answer: B
Diff: 2
Skill: Analytical
11) Refer to Instruction 10.1. Money market hedges almost always return more than forward hedges
because of the greater risk involved.
Answer: FALSE
Diff: 1
Skill: Conceptual
12) Refer to Instruction 10.1. If Plains States chooses to implement a money market hedge for the Euro
receivables, how much money will the firm borrow today?
A) euro 1,201,923
B) $1,201,923
C) euro 1,196,172
D) $1,196,172
Answer: C
Diff: 2
Skill: Analytical
13) Refer to Instruction 10.1. A ________ hedge allows Plains States to enjoy the benefits of a favorable
change in exchange rates for their euro receivables contract while protecting the firm from unfavorable
exchange rate changes.
A) forward
B) call option
C) put option
D) money market
Answer: C
Diff: 1
Skill: Conceptual
8
14) Refer to Instruction 10.1. What is the cost of a put option hedge for Plains States' euro receivable
contract? (Note: Calculate the cost in future value dollars and assume the firm's cost of capital as the
appropriate interest rate for calculating future values.)
A) $27,694
B) $26,250
C) euro 27,694
D) euro 26,250
Answer: A
Diff: 2
Skill: Analytical
15) Refer to Instruction 10.1. The cost of a call option to Plains States would be ________.
A) $17,653
B) $16,733
C) $18,471
D) There is not enough information to answer this question.
Answer: D
Diff: 2
Skill: Analytical
16) Refer to Instruction 10.1. If Plains States purchases the put option, and the option expires in six
months on the same day that Plains States receives the euro 1,250,000, the firm will exercise the put at
that time if the spot rate is $1.43/euro.
Answer: FALSE
Diff: 2
Skill: Analytical
17) The structure of a money market hedge is similar to a forward hedge. The difference is the cost of
the money market hedge is determined by the differential interest rates, while the forward hedge is a
function of the forward rates quotation.
Answer: TRUE
Diff: 1
Skill: Conceptual
18) In efficient markets, interest rate parity should assure that the costs of a forward hedge and money
market hedge should be approximately the same.
Answer: TRUE
Diff: 1
Skill: Conceptual
9
10.4 Translation Exposure
1) Translation exposure may also be called ________ exposure.

A) transaction
B) operating
C) accounting
D) currency
Answer: C
Diff: 1
Topic: 10.4 Translation Exposure
Skill: Recognition
2) ________ exposure is the potential for an increase or decrease in the parent company's net worth and
reported net income caused by a change in exchange rates since the last transaction.
A) Transaction
B) Operating
C) Currency
D) Translation
Answer: D
Diff: 1
Skill: Recognition
3) Translation exposure measures

A) changes in the value of outstanding financial obligations incurred prior to a change in exchange rates.
B) the potential for an increase or decrease in the parent company's net worth and reported net income
caused by a change in exchange rates since the last consolidation of international operations.
C) an unexpected change in exchange rates impact on short run expected cash flows.
D) none of the above.
Answer: B
Diff: 1
Skill: Recognition
4) According to your authors, the main purpose of translation is

A) to prepare consolidated financial statements.
B) to help management assess the performance of foreign subsidiaries.
C) to act as an interpreter for managers without foreign language skills.
Answer: A
Diff: 1
Skill: Recognition
10
5) If the same exchange rate were used to remeasure every line on a financial statement, then there
would be no imbalances from remeasuring.
Answer: TRUE
Diff: 1
Skill: Conceptual
6) Historical exchange rates may be used for ________, while current exchange rates may be used for
________.
A) fixed asses and current assets; income and expense items
B) equity accounts and fixed assets; current assets and liabilities
C) current assets and liabilities; equity accounts and fixed assets
D) equity accounts and current liabilities; current assets and fixed assets
Answer: B
Diff: 1
Skill: Conceptual
7) A foreign subsidiary's ________ currency is the currency used in the firm's day-to-day operations.
A) local
B) integrated
C) notational dollar
D) functional
Answer: D
Diff: 1
Skill: Recognition
8) The two basic methods for the translation of foreign subsidiary financial statements are the ________
method and the ________ method.
A) current rate; temporal
B) temporal; proper timing
C) current rate; future rate
Answer: A
Diff: 1
Skill: Recognition
9) Exchange rate imbalances that are passed through the balance sheet affect a firm's reported income,
but imbalances transferred to the income statement do not.
Answer: FALSE
Diff: 1
Skill: Recognition
11
10) The current rate method is the most prevalent method today for the translation of financial
statements.
Answer: TRUE
Diff: 1
Skill: Recognition
11) The temporal rate method is the most prevalent method today for the translation of financial
statements.
Answer: FALSE
Diff: 1
Skill: Recognition
12) Gains or losses caused by translation adjustments when using the current rate method are reported
separately on the ________.
A) consolidated statement of cash flow
B) consolidated income statement
C) consolidated balance sheet
Answer: C
Diff: 1
Skill: Recognition
13) The biggest advantage of the current rate method of reporting translation adjustments is the fact that
the gain or loss goes directly to the reserve account on the consolidated balance sheet and does not pass
through the consolidated income statement.
Answer: TRUE
Diff: 1
Skill: Recognition
14) Under the current rate method, specific assets and liabilities are translated at exchange rates
consistent with the timing of the item's creation.
Answer: FALSE
Diff: 1
Skill: Recognition
15) Under the temporal rate method, specific assets and liabilities are translated at exchange rates
consistent with the timing of the item's creation.
Answer: TRUE
Diff: 1
Skill: Recognition
12
16) The basic advantage of the ________ method of foreign currency translation is that foreign
nonmonetary assets are carried at their original cost in the parent's consolidated statement while the most
important advantage of the ________ method is that the gain or loss from translation does not pass
through the income statement.
A) monetary; current rate
B) temporal; current rate
C) temporal; monetary
D) current rate; temporal
Answer: D
Diff: 1
Skill: Conceptual
17) The current rate method of foreign currency translation gains or losses resulting from
remeasurement are carried directly to current consolidated income and thus introduces volatility to
consolidated earnings.
Answer: FALSE
Diff: 1
Skill: Recognition
18) The temporal method of foreign currency translation gains or losses resulting from remeasurement
are carried directly to current consolidated income and thus introduces volatility to consolidated
earnings.
Answer: TRUE
Diff: 1
Skill: Recognition
10.5 Trident Corporation's Translation Exposure
1) The main technique to minimize translation exposure is called a/an ________ hedge.
A) balance sheet
B) income statement
C) forward
D) translation
Answer: A
Diff: 1
Topic: 10.5 Trident Corporation's Translation Exposure
Skill: Recognition
13
2) A balance sheet hedge requires that the amount of exposed foreign currency assets and liabilities
A) have a 2:1 ratio of assets to liabilities.
B) have a 2:1 ratio of liabilities to assets.
C) have a 2:1 ratio of liabilities to equity.
D) be equal.
Answer: D
Diff: 1
Skill: Conceptual
3) If a firm's balance sheet has an equal amount of exposed foreign currency assets and liabilities and the
firm translates by the temporal method, then
A) the net exposed position is called monetary balance.
B) the change of value of liabilities and assets due to a change in exchange rates will be of equal but
opposite direction.
C) both A and B are true.
Answer: C
Diff: 1
Skill: Conceptual
4) If a firm's subsidiary is using the local currency as the functional currency, which of the following is
NOT a circumstance that could justify the use of a balance sheet hedge?
A) The foreign subsidiary is about to be liquidated, so that the value of its Cumulative Translation
Adjustment (CTA) would be realized.
B) The firm has debt covenants or bank agreements that state the firm's debt/equity ratio will be
maintained within specific limits.
C) The foreign subsidiary is operating is a hyperinflationary environment.
D) All of the above are appropriate reasons to use a balance sheet hedge.
Answer: D
Diff: 1
Skill: Conceptual
5) A Canadian subsidiary of a U.S. parent firm is instructed to bill an export to the parent in U.S. dollars.
The Canadian subsidiary records the accounts receivable in Canadian dollars and notes a profit on the
sale of goods. Later, when the U.S. parent pays the subsidiary the contracted U.S. dollar amount, the
Canadian dollar has appreciated 10% against the U.S. dollar. In this example, the Canadian subsidiary
will record a
A) 10% foreign exchange loss on the U.S. dollar accounts receivable.
B) 10% foreign exchange gain on the U.S. dollar accounts receivable.
C) since the Canadian firm is a U.S. subsidiary neither a gain nor loss will be recorded.
D) any gain or loss will be recorded only by the parent firm.
Answer: A
Diff: 1
Skill: Conceptual
14
6) ________ gains and losses are "realized" whereas ________ gains and losses are only "paper."
A) Translation; transaction
B) Transaction; translation
C) Translation; operating
D) None of the above
Answer: B
Diff: 1
Skill: Recognition
7) A balance sheet hedge is the main technique for managing ________.

A) transaction
B) operating
C) translation
D) money market
Answer: C
Diff: 1
Skill: Recognition
8) If the European subsidiary of a U.S. firm has net exposed assets of euro 500,000, and the euro drops
in value from $1.40/euro to $1.30/euro the U.S. firm has a translation ________.
A) gain of $50,000
B) loss of $50,000
C) gain of $450,000
D) loss of euro 450,000
Answer: B
Diff: 2
Skill: Analytical
9) If the European subsidiary of a U.S. firm has net exposed assets of euro 500,000, and the euro
increases in value from $1.30/euro to $1.35/euro the U.S. firm has a translation ________.
A) gain of $25,000
B) loss of $25,000
C) gain of $525,000
Answer: A
Diff: 2
Skill: Analytical
15
10.6 Managerial Implications
1) If a European subsidiary of a U.S. firm has net exposed liabilities of euro 500,000, and the euro drops
in value from $1.40/euro to $1.30/euro then the U.S. firm has a translation ________.
A) gain of $50,000
B) loss of $50,000
C) gain of $450,000
Answer: A
Diff: 2
Topic: 10.6 Managerial Implications
Skill: Analytical
2) If a European subsidiary of a U.S. firm has net exposed liabilities of euro 500,000, and the euro
increases in value from $1.30/euro to $1.35/euro then the U.S. firm has a translation ________.
A) gain of $25,000
B) loss of $25,000
C) gain of $525,000
Answer: B
Diff: 2
Skill: Analytical
3) Using the table below, estimate the net exposure for Souris River Manufacturing of it's wholly-owned
Canadian subsidiary.
A) C$40,000
B) C$160,000
C) C$166,000
D) C$200,000
Answer: C
Diff: 2
Skill: Analytical
16
Essay Questions
10.1 Types of Foreign Exchange Exposure
1) List and define the three types of foreign exchange exposure presented by your authors.
Answer: Transaction exposure 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 the exchange rates
change. Thus, it deals with changes in cash flows that result from existing contractual obligations.
Translation exposure is the potential for accounting-derived changes in owner's equity to occur because
of the need to "translate" foreign currency financial statements of foreign subsidiaries into a single
reporting currency to prepare worldwide consolidated financial statements.
Operating exposure, also called economic exposure, competitive exposure, or strategic exposure,
measures the change in the present value of the firm resulting from any change in future operating cash
flows of the firm caused by an unexpected change in exchange rates. The change in value depends on
the effect of the exchange rate change on future sales volume, prices, and costs.
Diff: 3
10.2 Why Hedge?
1) Does foreign currency exchange hedging both reduce risk and increase expected value? Explain, and
list several arguments in favor of currency risk management and several against.
Answer: Foreign exchange currency hedging can reduce the variability of foreign currency receivables
or payables by locking in a specific exchange rate in the future via a forward contract, converting
currency at the current spot rate using a money market hedge, or minimizing unfavorable exchange rate
movement with a currency option. None of these hedging techniques, however, increases the expected
value of the foreign currency exchange. In fact, expected value should fall by an amount equal to the
cost of the hedge.
Generally, those in favor of currency risk management find value in the reduction of variability of
uncertain cash flows. Those opposed to currency risk management argue the NPV of such activities are
$0 or less and that shareholders can reduce risk themselves more efficiently. For a more complete
answer to this question, see page 4 where the author outlines several arguments for and against currency
risk management.
Diff: 3
17
10.3 Trident's Transaction Exposure
1) Currency risk management techniques include forward hedges, money market hedges, and option
hedges. Draw a diagram showing the possible outcomes of these hedging alternatives for a foreign
currency receivable contract. In your diagram, be sure to label the X and Y-axis, the put option strike
price, and show the possible results for a money market hedge, a forward hedge, a put option hedge, and
an uncovered position. (Note: Assume the forward currency receivable is British pounds and the put
option strike price is $1.50/£, the price of the option is $0.04 the forward rate is $1.52/£ and the current
spot rate is $1.48/£.)
Answer: The student should draw and label a diagram that looks similar to the one found in exhibit
10.4.
Diff: 3
10.4 Translation Exposure
1) The two methods for the translation of foreign subsidiary financial statements are the current rate and
temporal methods. Briefly, describe how each of these methods translates the foreign subsidiary
financial statements into the parent company's consolidated statements. Identify when each technique
should be used and the major advantage(s) of each.
Answer: The current rate method translates almost all line items from the foreign subsidiary to the
parent consolidated statements at the current exchange rate. This is the most commonly used method in
the world today. Assets and liabilities are translated at current exchange rate and items found on the
income statement are translated at the actual exchange rate on the date of transaction, or as an average
over the statement period where appropriate. Equity accounts are translated at historical costs.
Any gains or loses caused by translation adjustments are typically placed into a special reserve account
(such as a CTA). Thus, gains or losses do not go through the income statement and do not increase the
volatility of net income. This is perhaps the biggest advantage to using the current rate method.
By contrast, the temporal method assumes that several individual financial statement items are
periodically restated to reflect their market value. The temporal method translates individual line items
based on monetary/nonmonetary criteria where monetary assets such as cash and marketable securities
are translated at current exchange rates, but nonmonetary assets such as fixed assets are translated at
historical rates. The gains or losses that result from translation remeasurement are recorded on the
consolidated income statement and impact upon the volatility of net income. The temporal method of
using historical costs may be more consistent with the practice of carrying domestic items at cost on the
financial statements.
Diff: 3
10.5 Trident Corporation's Translation Exposure
1) There are no essay questions for this section.
18
10.6 Managerial Implications
1) Describe a balance sheet hedge and give at least two examples of when such a hedge could be
justified.
Answer: A balance sheet hedge attempts to equalize the amount of assets and liabilities of a foreign
subsidiary exposed to translation risk. Thus, the gain to the firm from a change in exchange rates will be
perfectly offset by an equal and opposite loss. Firms may engage in balance sheet hedges under
conditions of hyperinflation, or when the subsidiary is about to be liquidated and the value of the CTA
account would be realized.
Diff: 3
19

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Chapter 10 Transaction and Translation Exposure Multiple Choice and True/False Questions 10.1 Types of Foreign Exchange Exposure

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What are the different types of foreign exchange exposure?

What are the different types of foreign exchange exposure?

What are some reasons why firms may choose to hedge currency exposures?

What are some reasons why firms may choose to hedge currency exposures?

Fundamentals of Multinational Finance, 4e (Moffett)

Chapter 10 Transaction and Translation Exposure

Multiple Choice and True/False Questions

10.1 Types of Foreign Exchange Exposure

10.2 Why Hedge?

1) ________ is a technique used by MNEs to deal with currency exposure.

∙ The spot exchange rate is $1.40/euro

1) Translation exposure may also be called ________ exposure.

3) Translation exposure measures

4) According to your authors, the main purpose of translation is

10.5 Trident Corporation's Translation Exposure

7) A balance sheet hedge is the main technique for managing ________.

10.1 Types of Foreign Exchange Exposure

10.2 Why Hedge?

10.4 Translation Exposure

10.5 Trident Corporation's Translation Exposure

1) There are no essay questions for this section.

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