11.3 You have learned about a number of ways of reducing risk, specifically hedging, insuring, and diversifying. In the table below, place an X in the cell for the technique being used to reduce risk. For each of the following below, identify if it is a strategy for hedging, insuring, or diversifying?
1. Placing an advance order with Amazon.ca, which agrees to charge you the lower of the advance price, and the price at the time your order is filled.
2. Purchasing a call option on a stock you think may go up in price.
3. Selling 200 shares of IBM and buying a mutual fund that holds the same stocks as the S&P index.
4. Selling a debt owed to you for $.50 per dollar owed.
5. Agreeing to a long-term contract with a supplier at a fixed price.
6. Agreeing to a no-trade clause with the sports team that employs you.
7. Buying a Mac and a PC.
8. Paying a clown to perform for your child's birthday party six months before the birthday.
11.4 Suppose you own 100 shares of Dell Inc. stock. Today it is trading at $15 per share, but you're worried Michael Dell might retire again, causing the price to go down. How would you protect yourself against his retirement, assuming you don't want to sell the shares today?© BrainMass Inc. brainmass.com October 17, 2018, 10:36 am ad1c9bdddf
Response to question 11.3
Hedging is a risk management method used to reduce your risk of the price increasing in the future.
Insuring is a risk management method used to reduce your risk by moving the risk to a third party.
Diversification is a risk management method used to mitigate risk by spreading risk over a variety of assets.
1 is an example of hedging your risk of a higher price by placing the order today.
2 is an example of hedging towards more profit by buying a call option. The hope is that the stock will increase in value.
3 is an example of diversifying your portfolio by increasing the number of stock from IBM to the 500 companies in the S&P index.
4 is an example of insuring risk management by passing a debt onto a third party. At the same time, you have collected ...
The expert examines hedging for finance questions. Advanced orders with Amazon.ca are determined.
International Finance multiple-choice questions : options, inflation, WACC, hedging, futures, interest rate parity etc.
1. Spears Co. will receive SF1,000,000 in 30 days. Use the following information to determine the total dollar amount received (after accounting for the option premium) if the firm purchases and exercises a put option:
Exercise price = $.61
Premium = $.02
Spot rate = $.60
Expected spot rate in 30 days = $.56
30 day forward rate = $.62
2. If U.S. inflation suddenly increased while European inflation stayed the same, there would be:
a. an increased U.S. demand for euros and an increased supply of euros for sale.
b. a decreased U.S. demand for euros and an increased supply of euros for sale.
c. a decreased U.S. demand for euros and a decreased supply of euros for sale.
d. an increased U.S. demand for euros and a decreased supply of euros for sale.
3. The Single European Act of 1987:
a. reduced competition in most industries.
b. eliminated competition in many industries.
c. reduced efficiency in most industries.
d. increased competition in most industries.
4. When computing the weighted average cost of capital, the weighting should be proportional based on the ______ rather than the _____ value of the firm.
a. book, market
b. hypothetical, book
c. market, analyst's
d. market, book
5. When the dollar strengthens, the reported consolidated earnings of U.S. based MNCs are _______ affected by translation exposure. When the dollar weakens, the reported consolidated earnings are __________ affected.
a. favorably; favorably affected but by a smaller degree
b. favorably; favorably affected by a higher degree
c. unfavorably; favorably affected
d. favorably; unfavorably affected
6. 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 firm's 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
7. The real cost of hedging payables with a forward contract equals:
a. the nominal cost of hedging minus the nominal cost of not hedging.
b. the nominal cost of not hedging minus the nominal cost of hedging.
c. the nominal cost of hedging divided by the nominal cost of not hedging.
d. the nominal cost of not hedging divided by the nominal cost of hedging.
8. Which of the following would likely have the least direct influence on a country's current account?
b. national income.
c. exchange rates.
e. a tax on income earned from foreign stocks.
9. Over time, international trade (exports plus imports) as a percentage of GDP has:
a. increased for most major countries.
b. decreased for most major countries.
c. stayed about constant for most major countries.
d. increased for about half the major countries and decreased for the others.
10. 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 the above, since a perfect hedge is nearly impossible.
11. A recent study by McKinsey & Co. found that investors assign a higher value to firms that exhibit ________ corporate governance standards and are likely to ________ ethical constraints.
a. high; not obey
b. high; obey
c. low; not obey
d. low; obey
12. If the current 180 day inter-bank Eurodollar rate is 15% (all rates are stated on an annualized basis. and next period's LIBOR is 13%, then a Eurocurrency loan priced at LIBOR plus 1% will cost
a. 16% this period and 16% next period
b. 15% this period and 14% next period
c. 16% this period and 14% next period
d. 15% this period and 15% next period
13. _______is not a factor that affects the bid/ask spread.
a. Order costs
b. Inventory costs
d. All of the above factors affect the bid/ask spread
14. Assume the Canadian dollar is equal to $.88 and the Peruvian Sol is equal to $.35. The value of the Peruvian Sol in Canadian dollars is:
a. about .3621 Canadian dollars.
b. about .3977 Canadian dollars.
c. about 2.36 Canadian dollars.
d. about 2.51 Canadian dollars.
15. _______ is not a bank characteristic important to customers in need of foreign exchange.
a. Quote competitiveness
b. Speed of execution
c. Forecasting advice
d. Advice about current market conditions
e. All of the above are important bank characteristics to customers in need of foreign exchange.
16. Which of the following is not an advantage resulting from the Asian crisis that would favor direct foreign investment in Asia?
a. strong local demand for products.
b. low production costs.
c. weak local currencies.
d. all of the above are advantages.
17. LIBOR is:
A) the interest rate commonly charged for loans between banks.
B) the average inflation rate in European countries.
C) the maximum loan rate ceiling on loans in the international money market.
D) the maximum deposit rate ceiling on deposits in the international money market.
E) the maximum interest rate offered on bonds that are issued in London.
18. Futures contracts are typically _______; forward contracts are typically _______.
A) sold on an exchange; sold on an exchange
B) offered by commercial banks; sold on an exchange
C) sold on an exchange; offered by commercial banks
D) offered by commercial banks; offered by commercial banks
19. The value of the Australian dollar (A$) today is $0.73. Yesterday, the value of the Australian dollar was $0.69. The Australian dollar ________ by _______%.
A) depreciated; 5.80
B) depreciated; 4.00
C) appreciated; 5.80
D) appreciated; 4.00
20. An increase in U.S. interest rates relative to German interest rates would likely ________ the U.S. demand for euros and _________ the supply of euros for sale.
A) reduce; increase
B) increase; reduce
C) reduce; reduce
D) increase; increase
21. Baylor Bank believes the New Zealand dollar will appreciate over the next five days from $.48 to $.50. The following annual interest rates apply:
Currency Lending Rate Borrowing Rate
Dollars 7.10% 7.50%
New Zealand dollar (NZ$) 6.80% 7.25%
Baylor Bank has the capacity to borrow either NZ$10 million or $5 million. If Baylor Bank's forecast if correct, what will its dollar profit be from speculation over the five day period (assuming it does not use any of its existing consumer deposits to capitalize on its expectations)?
22. Assume that British corporations begin to purchase more supplies from the U.S. as a result of several labor strikes by British suppliers. This action reflects:
A) an increased demand for British pounds.
B) a decrease in the demand for British pounds.
C) an increase in the supply of British pounds for sale.
D) a decrease in the supply of British pounds for sale.
23. 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.
24. Assume no transactions costs exist for any futures or forward contracts. The price of British pound futures with a settlement date 180 days from now will:
A) definitely be above the 180 day forward rate.
B) definitely be below the 180 day forward rate.
C) be about the same as the 180 day forward rate.
D) none of the above; there is no relation between the futures and forward prices.
25. Kalons, Inc. is a U.S.-based MNC that frequently imports raw materials from Canada. Kalons is typically invoiced for these goods in Canadian dollars and is concerned that the Canadian dollar will appreciate in the near future. Which of the following is not an appropriate hedging technique under these circumstances?
A) purchase Canadian dollars forward.
B) purchase Canadian dollar futures contracts.
C) purchase Canadian dollar put options.
D) purchase Canadian dollar call options.
26. A firm will likely benefit most from diversifying if:
A) the correlations between country economies are high.
B) the correlations between country economies are low.
C) the variability of all country economy levels is high.
D) B and C
27. Assume that a bank's bid rate on Swiss francs is $.45 and its ask rate is $.47. Its bid ask percentage spread is:
A) about 4.44%.
B) about 4.26%.
C) about 4.03%.
D) about 4.17%.
28. Thornton, Inc. needs to invest five million Nepalese rupees in its Nepalese subsidiary to support local operations. Thornton would like its subsidiary to repay the rupees in one year. Thornton would like to engage in a swap transaction. Thus, Thornton would:
A) convert the rupees to dollars in the spot market today and convert rupees to dollars in one year at today's forward rate.
B) convert the dollars to rupees in the spot market today and convert dollars to rupees in one year at the prevailing spot rate.
C) convert the dollars to rupees in the spot market today and convert rupees to dollars in one year at today's forward rate.
D) convert the dollars to rupees in the spot market today and convert rupees to dollars in one year at the prevailing spot rate.
29. An increase in the current account deficit will place _______ pressure on the home currency value, other things equal.
D) upward or downward (depending on the size of the deficit)
30. Forward contracts:
A) contain a commitment to the owner, and are standardized.
B) contain a commitment to the owner, and can be tailored to the desire of the owner.
C) contain a right but not a commitment to the owner, and can be tailored to the desire of the owner.
D) contain a right but not a commitment to the owner, and are standardized.
31. _____________ are most commonly classified as a direct foreign investment.
A) Foreign acquisitions
B) Purchases of international stocks
C) Licensing agreements
D) Exporting transactions
32. Which of the following is true?
A) Most forward contracts between firms and banks are for speculative purposes.
B) Most future contracts represent a conservative approach by firms to hedge foreign trade.
C) The forward contracts offered by banks have maturities for only four possible dates in the future.
D) none of the above
33. Which one of the following is an advantage of international investing?
a. you can invest in industries that don't exist in the United States
b. you can invest in companies that have lower price earnings ratios
c. you can invest in companies that are, on average, more profitable than similar U.S. firms
d. you can invest in companies with lower market book value ratios
34. To force the value of the pound to appreciate against the dollar, the Federal Reserve should:
A) sell dollars for pounds in the foreign exchange market and the European Central Bank (ECB) should sell dollars for pounds in the foreign exchange market.
B) sell pounds for dollars in the foreign exchange market and the European Central Bank (ECB) should sell dollars for pounds in the foreign exchange market.
C) sell pounds for dollars in the foreign exchange market and the European Central Bank (ECB) should not intervene.
D) sell dollars for pounds in the foreign exchange market and the European Central Bank (ECB) should sell pounds for dollars in the foreign exchange market.
35. Consider two countries that trade with each other, called X and Y. Inflation in Country X will have a greater impact on inflation in Country Y under the _______ system. Now, consider two other countries that trade with each other, called A and B. Unemployment in Country A will have a greater impact on unemployment in Country B under the _______ system.
A) floating rate; fixed rate
B) floating rate; floating rate
C) fixed rate; fixed rate
D) fixed rate; floating rate
36. The value of the Canadian dollar, Japanese yen, and Australian dollar with respect to the U.S. dollar are part of a:
A) pegged system.
B) fixed system.
C) managed float system.
D) crawling peg system.
37. If the Fed desires to weaken the dollar without affecting the dollar money supply, it should:
A) exchange dollars for foreign currencies, and sell some of its existing Treasury security holdings for dollars.
B) exchange foreign currencies for dollars, and sell some of its existing Treasury security holdings for dollars.
C) exchange dollars for foreign currencies, and buy existing Treasury securities with dollars.
D) exchange foreign currencies for dollars, and buy existing Treasury securities with dollars.
38. Due to _______, market forces should realign the relation¬ship between the interest rate differential of two currencies and the forward premium (or discount) on the forward exchange rate between the two currencies.
A) forward realignment arbitrage
B) triangular arbitrage
C) covered interest arbitrage
D) locational arbitrage
39. If the interest rate is lower in the U.S. than in the United Kingdom, and if the forward rate of the British pound is the same as its spot rate:
A) U.S. investors could possibly benefit from covered interest arbitrage.
B) British investors could possibly benefit from covered interest arbitrage.
C) neither U.S. nor British investors could benefit from covered interest arbitrage.
D) A and B
40. Based on interest rate parity, the larger the degree by which the foreign interest rate exceeds the U.S. interest rate, the:
A) larger will be the forward discount of the foreign currency.
B) larger will be the forward premium of the foreign currency.
C) smaller will be the forward premium of the foreign currency.
D) smaller will be the forward discount of the foreign currency.