Learning objectives: Describe examples of transaction, translation, and economic risks and explain how to hedge these risks. Describe the rationale for multi-currency hedging using options. Identify and explain the factors that determine exchange rates. Calculate and explain the effect of an appreciation/depreciation of one currency relative to another.
Questions:
22.16.1. The three types of foreign exchange risk are transaction risk, translation risk, and economic risk. Due to the textual resemblance between the first two, we will denote them as transaction (AC) and translation (LA) risk. In regard to these risks, each of the following statements is true EXCEPT which is false?
a. Translation (LA) risk, in general, should be netted against transaction (AC) risk
b. Translation (LA) risk does not affect the firm's cash flow but might have a big effect on reported earnings
c. Translation (LA) risk can be avoided by financing assets in the foreign country with borrowings in that same country
d. Economic risk is harder to quantify than either transaction or translation risk but can affect the firm's future cash flows via supply/demand or competitive dynamics
22.16.2. The spot exchange rate for EURJPY (aka, Yuppy) is ¥133.00 where the Japanese Yen is the quote currency. Over the next period, the expected inflation rates in the eurozone and Japan, respectively, are +5.50% and +1.10%. According to purchasing power parity, which of the following is TRUE?
a. Appreciation in the euro (EUR) to about ¥143.06 EURJPY
b. Depreciation in the euro (EUR) to about ¥127.15 EURJPY
c. Depreciation in the Yen (JPY) to about €0.0067 JPYEUR
d. Incomplete information because we need their respective riskfree rates
22.16.3. Italy exports over $50.0 billion in products to the United States (U.S.), including machinery/equipment, pharmaceuticals, vehicles, beverages, and commodities. According to the balance of payments (and trade flows), if Italy increases its exports to the U.S., which of the following is most likely:
I. Increase in the EURUSD exchange rate
II. As an equilibrating force, there will lower quantity demanded in the US for the imported Italian good
a. Only I
b. Only II
c. Both I and II
d. Neither
Answers here:
Questions:
22.16.1. The three types of foreign exchange risk are transaction risk, translation risk, and economic risk. Due to the textual resemblance between the first two, we will denote them as transaction (AC) and translation (LA) risk. In regard to these risks, each of the following statements is true EXCEPT which is false?
a. Translation (LA) risk, in general, should be netted against transaction (AC) risk
b. Translation (LA) risk does not affect the firm's cash flow but might have a big effect on reported earnings
c. Translation (LA) risk can be avoided by financing assets in the foreign country with borrowings in that same country
d. Economic risk is harder to quantify than either transaction or translation risk but can affect the firm's future cash flows via supply/demand or competitive dynamics
22.16.2. The spot exchange rate for EURJPY (aka, Yuppy) is ¥133.00 where the Japanese Yen is the quote currency. Over the next period, the expected inflation rates in the eurozone and Japan, respectively, are +5.50% and +1.10%. According to purchasing power parity, which of the following is TRUE?
a. Appreciation in the euro (EUR) to about ¥143.06 EURJPY
b. Depreciation in the euro (EUR) to about ¥127.15 EURJPY
c. Depreciation in the Yen (JPY) to about €0.0067 JPYEUR
d. Incomplete information because we need their respective riskfree rates
22.16.3. Italy exports over $50.0 billion in products to the United States (U.S.), including machinery/equipment, pharmaceuticals, vehicles, beverages, and commodities. According to the balance of payments (and trade flows), if Italy increases its exports to the U.S., which of the following is most likely:
I. Increase in the EURUSD exchange rate
II. As an equilibrating force, there will lower quantity demanded in the US for the imported Italian good
a. Only I
b. Only II
c. Both I and II
d. Neither
Answers here:
