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Exchange rate risk

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DFI Location Decision.

Decko Co. is a US firm with a Chinese subsidiary that produces cell phones in China and sells them in Japan. This subsidiary pays its wages and its rent in Chinese yuan, which is stable relative to the dollar. The cell phones sold to Japan are denominated in Japanese yen. Assume that Decko Co. expects that the Chinese yuan will continue to stay stable against the dollar. The subsidiary's main goal is to generate profits for itself and reinvest the profits. It does not plan to remit any funds to the US parent.

a) Assume that the Japanese yen strengthens against the US dollar over time. How would this be expected to affect the profits earned by the Chinese subsidiary.
b) If Decko Co. had established its subsidiary in Tokyo, Japan, instead of China, would its subsidiary's profits be more exposed or less exposed to exchange rate risk?
c) Why do you think that Decko Co. established the subsidiary in China instead of Japan? Assume no major country risk barriers.
d) If the Chinese subsidiary needs to borrow money to finance its expansion and wants to reduce its exchange rate risk, should it borrow US dollars, Chinese yuan, or Japanese yen?

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a. If Yen strengthens against the dollar, it would also strengthen against the Yuan. Therefore the cash flow from sales when converted to Yuan from Yen would be higher. Thus the profits of the firm would increase since it would get more Yuan for the same ...

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The solution explains various questions relating to exchange rate risk

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Multiple choice questions on Derivatives, futures, options, currencies, hedges, exchange rate risk

I need help in answering the questions below.

Please provide your answers on the Excel Answer Template attached.

1. Graylon, Inc., based in Washington, exports products to a German firm and will receive payment of ?200,000 in three months. On June1, the spot rate of the euro was $1.12, and the 3-month forward rate was $1.10. On June 1, Graylon negotiated a forward contract with a bank to sell ?200,000 forward in three months.The spot rate of the euro on September 1 is $1.15. Graylon will receive $_________ for the euros.

A) 224,000
B) 220,000
C) 200,000
D) 230,000

2. 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.

3. Which of the following is the most unlikely strategy for a U.S. firm that will be purchasing Swiss francs in the future and desires to avoid exchange rate risk (assume the firm has no offsetting position in francs)?
A) purchase a call option on francs.
B) obtain a forward contract to purchase francs forward.
C) sell a futures contract on francs.
D) all of the above are appropriate strategies for the scenario described.

4. If your firm expects the euro to substantially depreciate, it could speculate by _______ euro call options or _______ euros forward in the forward exchange market.
A) selling; selling
B) selling; purchasing
C) purchasing; purchasing
D) purchasing; selling

5. Assume that a speculator purchases a put option on British pounds (with a strike price of $1.50) for $.05 per unit. A pound option represents 31,250 units. Assume that at the time of the purchase, the spot rate of the pound is $1.51 and continually rises to $1.62 by the expiration date. The highest net profit possible for the speculator based on the information above is:
A) $1,562.50.
B) -$1,562.50.
C) -$1,250.00.
D) -$625.00.

6. Which of the following is true?
A) The futures market is primarily used by speculators while the forward market is primarily used for hedging.
B) The futures market is primarily used for hedging while the forward market is primarily used for speculating.
C) The futures market and the forward market are primarily used for speculating.
D) The futures market and the forward market are primarily used for hedging.

7. A U.S. firm is bidding for a project needed by the Swiss government. The firm will not know if the bid is accepted until three months from now. The firm will need Swiss francs to cover expenses but will be paid by the Swiss government in dollars if it is hired for the project. The firm can best insulate itself against exchange rate exposure by:
A) selling futures in francs.
B) buying futures in francs.
C) buying franc put options.
D) buying franc call options.

8. A firm wants to use an option to hedge 12.5 million in receivables from New Zealand firms. The premium is $.03. The exercise price is $.55. If the option is exercised, what is the total amount of dollars received (after accounting for the premium paid)?
A) $6,875,000.
B) $7,250,000.
C) $7,000,000.
D) $6,500,000.
E) none of the above

9. The existing spot rate of the Canadian dollar is $.82. The premium on a Canadian dollar call option is $.04. The exer¬cise price is $.81. The option will be exercised on the expiration date, if at all. If the spot rate on the expira¬tion date is $.87, the profit as a percent of the initial invest¬ment (the premium paid) is:
A) 0 percent.
B) 25 percent.
C) 50 percent.
D) 150 percent.
E) none of the above

10. Macomb Corporation is a U.S. firm that invoices some of its exports in Japanese yen. If it expects the yen to weaken, it could _______ to hedge the exchange rate risk on those exports.
A) sell yen put options
B) buy yen call options
C) buy futures contracts on yen
D) sell futures contracts on yen

11. A U.S. corporation has purchased currency put options to hedge a 100,000 Canadian dollar (C$) receivable. The premium is $.01 and the exercise price of the option is $.75. If the spot rate at the time of maturity is $.85, what is the net amount received by the corporation if it acts rationally?
A) $74,000.
B) $84,000.
C) $75,000.
D) $85,000.

12. Johnson, Inc., a U.S.-based MNC, will need 10 million Thai baht on August 1. It is now May 1. Johnson has negotiated a non-deliverable forward contract with its bank. The reference rate is the baht's closing exchange rate (in $) quoted by Thailand's central bank in 90 days. The baht's spot rate today is $.02. If the rate quoted by Thailand's central bank on August 1 is $.022, Johnson will ________ $__________.
A) pay; 20,000
B) be paid; 20,000
C) pay; 2,000
D) be paid; 2,000
E) none of the above

13. Which of the following are true regarding the options markets?
A) Hedgers and speculators both attempt to lower risk.
B) Hedgers attempt to lower risk, while speculators attempt to make riskless profits.
C) Hedgers and speculators are both necessary in order for the market to be liquid.
D) all of the above

14. Your company expects to receive 5,000,000 Japanese yen 60 days from now. You decide to hedge your position by selling Japanese yen forward. The current spot rate of the yen is $.0089, while the forward rate is $.0095. You expect the spot rate in 60 days to be $.0090. How many dollars will you receive for the 5,000,000 yen 60 days from now?
A) $44,500.
B) $45,000.
C) $526 million.
D) $47,500.

The following is not a multiple choice question and will require you to provide your answer using the table provided in the excel answer template.

15. Assume that the transactions listed below are anticipated by U.S. firms that have no other foreign transactions. In the excel file, place an "X" in the yellow boxes contained in the table wherever you see possible ways to hedge each of the transactions (some transactions/lines will have more than one "X' per line).

a. Georgetown Co. plans to purchase Japanese goods denominated in yen.
b. Harvard, Inc., sold goods to Japan, denominated in yen.
c. Yale Corp. has a subsidiary in Australia that will be remitting funds to the U.S. parent.
d. Brown, Inc., needs to pay off existing loans that are denominated in Canadian dollars.
e. Princeton Co. may purchase a company in Japan in the near future (but the deal may not go through).

Forward Contract Futures Contract Options Contract
Trans- Forward Forward Buy Sell Purchase Purchase
action Purchase Sale Futures Futures Calls Puts

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