1. Describe an “Options Market Hedge”; what would you purchase if you expected a currency to appreciate and what would you purchase if you expected a currency to depreciate? Why is it a Hedge?
2. Should a firm hedge? Yes or No?
3. Define the term, “cost of capital” as it relates to multinational corporations. Describe to me how the cost of capital can change if you an international market as opposed to a domestic market.
4. Dell Computers sold a super computer to the Institute in Italy on credit and invoiced €5 million payable in six months. Currently, the six-month forward exchange rate is $1.15/€ and the foreign exchange advisor for Dell Computers predicts that the spot rate is likely to be $1.03/€ in six months.
What is the expected gain/loss from the forward hedging?
(a) If you were the financial manager of Dell Computers, would you recommend hedging this euro receivable? Why or why not?
(b) Suppose the foreign exchange advisor predicts that the future spot rate will be the same as the forward exchange rate quoted today. Would you recommend hedging in this case? Why or why not?
5. What are the advantages and disadvantages of financial hedging of the firm’s operating exposure compared to operational hedges (such as relocating a research & development site or moving a factory overseas and hiring foreign labor)?
6. Chrysler exports cars to Portugal but the strong dollar against the Euro hurts sales of Chrysler cars in Portugal. In the Portugese market, Chrysler faces competition from the Italian and French car makers, such as Fiat and Renault, whose currencies remain stable relative to the Euro. What kind of measures would you recommend so that Chrysler can maintain its market share in Portugal.
7. Explain the competitive and conversion effects of exchange rate changes on the firm’s operating cash flow. How will currency fluctuations effect the income statement and the balance sheet?
8. What is meant by the terminology that an option is in-, at- or out of the money. Provide an example of each.
9. Explain the following statement: “Exposure is the regression coefficient with regards to Management of Economic Exposure.”
10. How would you define economic exposure to exchange risk?
11. Tell me how corporations are becoming multinational not only in the scope of their business activities but also in their capital structure.
12. Give me 3 examples of how Cross-border listings of stocks benefit a company and 3 examples of the costs of cross-border listings of stocks.
13. A U.S. firm holds an asset in France and faces the following scenario:
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State 1
State 1
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State 2
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State 3
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State 4
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|
Probability
Probability
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25%
25%
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25%
|
25%
|
25%
|
|
Spot Rate
Spot rate
|
$2.00/ E
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$1.80/E
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$1.60/E
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$1.40/E
|
|
P*
P*
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E1,300
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E1,200
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E1,100
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E1,000
|
|
P
P
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$2,600
|
$2,160
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$1,760
|
$1,400
|
In the above table, P* is the euro price of the asset held by the U.S. firm and P is the dollar price of the asset.
(a) Compute the exchange exposure faced by the U.S. firm.
(b) What is the variance of the dollar price of this asset if the U.S. firm remains unhedged against this exposure
(c) Discuss how you can hedge your exchange risk exposure and also examine the consequences of hedging
14. Suppose that you hold a piece of land in the City of Paris that you may want to sell in one year. As a U.S. resident, you are concerned with the dollar value of the land. Assume that, if the French economy booms in the future, the land will be worth E4,000 and one Euro will be worth $1.50. If the French economy slows down, on the other hand, the land will be worth less, i.e., E2,000 but the Euro will be stronger, i.e. $1.20. You feel that the French economy will experience a boom with a 75% probability and a slow-down with a 25% probability.
(a) Estimate your exposure b to the exchange risk.
(b) Compute the variance of the dollar value of your property that is attributable to the exchange rate uncertainty.
(c) Discuss how you can hedge your exchange risk exposure and also examine the consequences of hedging in this case.
15. Answer problems a, b, c based on the stock market data given by the following table.
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Parmalat
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France
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World
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SD(%)
|
 (%)
|
|
Parmalat
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1.00
|
.90
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0.60
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20
|
?
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France
|
|
1.00
|
0.75
|
14
|
18
|
|
World
|
|
|
1.00
|
10
|
12
|
The above table provides the correlations among Parmalat, a dairy company located in France, the French stock market index, and the world market index, together with the standard deviations (SD) of returns and the expected returns (). The risk-free rate is 5%.
a. Compute the domestic country beta of Parmalat as well as its world beta. What do these betas measure?
b. Suppose the French stock market is segmented from the rest of the world. Using the CAPM paradigm, estimate the equity cost of capital of Parmalat.
c. Suppose now that Parmalat has made its shares tradable internationally via cross-listing on NYSE. Again using the CAPM paradigm, estimate Parmalat’s equity cost of capital. Discuss the possible effects of international pricing of Parmalat’s shares on the share prices and the firm’s investment decisions
16. The common stock of Duke Power and Light has a beta of 0.80. The Treasury bill rate is 5 percent and the market risk premium is 9 percent. Duke Power and Light is in the 28% tax bracket. What is their cost of equity capital?
17. Discuss the advantages and disadvantages of maintaining multiple manufacturing sites as a hedge against exchange rate exposure?
18. Hewlett Packard purchased computer chips from Simens, a German electronics concern, and was billed 5 million Euros payable in three months. Currently, the spot exchange rate is $1.46/Euro and the three-month forward rate is $1.51/Euro. The three-month money market interest rate is 8 percent per annum in the U.S. and 7 percent per annum in Germany. The management of Hewlett Packard decided to use the money market hedge to deal with this Euro account payable.
(a) Explain the process of a money market hedge and compute the dollar cost of meeting the yen obligation.
(b) Conduct the cash flow analysis of the money market hedge.
19. Verizon Phone Company, an American firm, is estimating their profit in Germany for next year. They are predicting sales in Germany of 200,000 units at 89 euros per unit. Their variable costs are 35 euros per unit and their fixed costs are 6,000,000 euros. Additionally, the tax rate that is to be paid to the German government is 30%. Assume there are no other charges to the company.
a) what is the predicted net income in Euros?
b) if the prediction changes to 250,000 units of sales, how will this change the predicted net income? (all the other data remains unchanged)?
c) if the prediction decreases to 230,000 units of sales and the variable costs increase to 38 euros per unit, how will this change the predicted net income (all the other data remains unchanged)?
d) The net income for this German unit will be reported on 12/31 and then the profits need to be translated back to the United States. What is the risk in this situation and how can the American parent decrease this risk?
20. Talk to me about the relationship between volatility and the price of an option. (as volatility increases or decreases what happens to the price of an option?).
21. When volatility decreases, how can you make money with currency options? What is your risk in this situation?
23. From the perspective of an international fixed income investor, you can choose to invest in either an UNHEDGED BOND FUND or a HEDGED BOND Fund. What is the difference and what risks are inherent in each fund?
24. Suppose your company has purchased a put option on the euro to manage exchange exposure associated with an account receivable denominated in that currency. In this case, your company can be said to have an “insurance” policy on that receivable. Explain why this is so.
25. How can a company limit the downside risk of currency exposure, while still preserving all the upside potential?