FIN 480 UPDATED EXAM TEST PAPER QUESTIONS AND
SOLUTIONS GUARANTEE A+
✔✔A U.S. firm sells merchandise today to a British company for £150,000. The current
exchange rate is $1.55/£ , 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. If the exchange rate changes to $1.58/£ the U.S. firm will realize a
________ of ________.
A) loss; $4,500
B) gain; $4,500
C) loss; £4,500
D) gain; £4,500 - ✔✔B) gain; $4,500
✔✔A U.S. firm sells merchandise today to a British company for £150,000. The current
exchange rate is $1.55/£ , 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. If the exchange rate changes to $1.52/£ the U.S. firm will realize a
________ of ________.
A) loss; $4,500
B) gain; $4,500
C) loss; £4,500
D) gain; £4,500 - ✔✔A) loss; $4,500
✔✔________ is NOT a commonly used 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. - ✔✔D) All of the above are contractual
hedges.
✔✔A ________ hedge refers to an offsetting operating cash flow such as a payable
arising from the conduct of business.
A) financial
B) natural
C) contractual
D) futures - ✔✔B) natural
✔✔Central Valley Transit Inc. (CVT) has just signed a contract to purchase light rail
cars from a manufacturer in Germany for euro 3,000,000. The purchase 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, CVT 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 $1.250/euro
∙ The six month forward rate is $1.22/euro
∙ CVT's 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 call options for euro 750,000; strike - ✔✔
✔✔Refer to Instruction 10.1. If CVT chooses NOT to hedge their euro payable, the
amount they pay in six months will be:
A) $3,500,000.
B) $3,900,000.
C) €3,000,000.
D) unknown today - ✔✔D) unknown today
✔✔Refer to Instruction 10.1. If CVT chooses to hedge its transaction exposure in the
forward market, it will ________ euro 3,000,000 forward at a rate of ________.
A) buy; $1.22
B) buy; $1.25
C) sell; $1.22
D) sell; €1.25 - ✔✔A) buy; $1.22
✔✔Refer to Instruction 10.1. CVT chooses to hedge its transaction exposure in the
forward market at the available forward rate. The required amount in dollars to pay off
the accounts payable in 6 months will be:
A) $3,000,000.
B) $3,660,000.
C) $3,750,000.
D) $3,810,000. - ✔✔B) $3,660,000.
✔✔Refer to Instruction 10.1. If CVT locks in the forward hedge at $1.22/euro, and the
spot rate when the transaction was recorded on the books was $1.25/euro, this will
result in a "foreign exchange accounting transaction ________ of ________.
A) loss; $90,000.
B) loss; €90,000.
C) gain; $90,000.
D) gain; €90,000. - ✔✔C) gain; $90,000
✔✔Refer to Instruction 10.1. CVT 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; $150,000
B) better off; €150,000
C) worse off; $150,000
,D) worse off; €150,000 - ✔✔A) better off; $150,000
✔✔Refer to Instruction 10.1. What is the cost of a call option hedge for CVT's 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) $57,600
B) $59,904
C) $62,208
D) $63,936 - ✔✔B) $59,904
✔✔Refer to Instruction 10.1. The cost of a put option to CVT would be:
A) $52,500.
B) $55,388.
C) $58,275.
D) There is not enough information to answer this question. - ✔✔D) There is not enough
information to answer this question.
✔✔When there is a full forward cover with the spot rate equal to the forward rate all of
the following are true EXCEPT:
A) The hedge is asymmetric.
B) There is no uncovered exposure remaining.
C) The total position is a perfect hedge.
D) The currency hedge ratio is equal to 1. - ✔✔A) The hedge is asymmetric.
✔✔________ are transactions for which there are, at present, no contracts or
agreements between parties.
A) Backlog exposure
B) Quotation exposure
C) Anticipated exposure
D) none of the above - ✔✔C) Anticipated exposure
✔✔According to a survey by Bank of America, the type of foreign exchange risk most
often hedged by firms is:
A) translation exposure.
B) transaction exposure.
C) contingent exposure.
D) economic exposure. - ✔✔B) transaction exposure.
✔✔________ is the possibility that the borrower's creditworthiness is reclassified by the
lender at the time of renewing credit. ________ is the risk of changes in interest rates
charged at the time a financial contract rate is set.
A) Credit risk; Interest rate risk
B) Repricing risk; Credit risk
C) Interest rate risk; Credit risk
, D) Credit risk; Repricing risk - ✔✔D) Credit risk; Repricing risk
✔✔Some of the world's largest and most financially sound firms may borrow at variable
rates less than LIBOR. - ✔✔TRUUUU
✔✔The London Interbank Offered Rate (LIBOR) is published under the auspices of the
British Bankers Association. A panel of 16 major multinational banks self-report their
actual borrowing rate. - ✔✔FALSE
Explanation: Each day, a panel of 16 major multinational banks is requested to submit
estimated borrowing rates. Rates are based on "estimated borrowing rates" to avoid
reporting only actual transactions - discretionary.
✔✔The basis point spreads between credit ratings dramatically rise for borrowers of
credit qualities less than BBB. - ✔✔TRUE
✔✔The single largest interest rate risk of a firm is:
A) interest sensitive securities.
B) debt service.
C) dividend payments.
D) accounts payable. - ✔✔B) debt service.
✔✔For the following problem(s), consider these debt strategies being considered by a
corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year
period.
∙ Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
∙ Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be
reset annually. The current LIBOR rate is 3.50%
∙ Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit
annually. The current one-year rate is 5%. - ✔✔
✔✔Refer to Instruction 8.1. Choosing strategy #1 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit
and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period. -
✔✔D) preclude the possibility of sharing in lower interest rates over the three-year
period.
✔✔Refer to Instruction 8.1. Choosing strategy #2 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
SOLUTIONS GUARANTEE A+
✔✔A U.S. firm sells merchandise today to a British company for £150,000. The current
exchange rate is $1.55/£ , 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. If the exchange rate changes to $1.58/£ the U.S. firm will realize a
________ of ________.
A) loss; $4,500
B) gain; $4,500
C) loss; £4,500
D) gain; £4,500 - ✔✔B) gain; $4,500
✔✔A U.S. firm sells merchandise today to a British company for £150,000. The current
exchange rate is $1.55/£ , 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. If the exchange rate changes to $1.52/£ the U.S. firm will realize a
________ of ________.
A) loss; $4,500
B) gain; $4,500
C) loss; £4,500
D) gain; £4,500 - ✔✔A) loss; $4,500
✔✔________ is NOT a commonly used 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. - ✔✔D) All of the above are contractual
hedges.
✔✔A ________ hedge refers to an offsetting operating cash flow such as a payable
arising from the conduct of business.
A) financial
B) natural
C) contractual
D) futures - ✔✔B) natural
✔✔Central Valley Transit Inc. (CVT) has just signed a contract to purchase light rail
cars from a manufacturer in Germany for euro 3,000,000. The purchase 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, CVT 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 $1.250/euro
∙ The six month forward rate is $1.22/euro
∙ CVT's 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 call options for euro 750,000; strike - ✔✔
✔✔Refer to Instruction 10.1. If CVT chooses NOT to hedge their euro payable, the
amount they pay in six months will be:
A) $3,500,000.
B) $3,900,000.
C) €3,000,000.
D) unknown today - ✔✔D) unknown today
✔✔Refer to Instruction 10.1. If CVT chooses to hedge its transaction exposure in the
forward market, it will ________ euro 3,000,000 forward at a rate of ________.
A) buy; $1.22
B) buy; $1.25
C) sell; $1.22
D) sell; €1.25 - ✔✔A) buy; $1.22
✔✔Refer to Instruction 10.1. CVT chooses to hedge its transaction exposure in the
forward market at the available forward rate. The required amount in dollars to pay off
the accounts payable in 6 months will be:
A) $3,000,000.
B) $3,660,000.
C) $3,750,000.
D) $3,810,000. - ✔✔B) $3,660,000.
✔✔Refer to Instruction 10.1. If CVT locks in the forward hedge at $1.22/euro, and the
spot rate when the transaction was recorded on the books was $1.25/euro, this will
result in a "foreign exchange accounting transaction ________ of ________.
A) loss; $90,000.
B) loss; €90,000.
C) gain; $90,000.
D) gain; €90,000. - ✔✔C) gain; $90,000
✔✔Refer to Instruction 10.1. CVT 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; $150,000
B) better off; €150,000
C) worse off; $150,000
,D) worse off; €150,000 - ✔✔A) better off; $150,000
✔✔Refer to Instruction 10.1. What is the cost of a call option hedge for CVT's 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) $57,600
B) $59,904
C) $62,208
D) $63,936 - ✔✔B) $59,904
✔✔Refer to Instruction 10.1. The cost of a put option to CVT would be:
A) $52,500.
B) $55,388.
C) $58,275.
D) There is not enough information to answer this question. - ✔✔D) There is not enough
information to answer this question.
✔✔When there is a full forward cover with the spot rate equal to the forward rate all of
the following are true EXCEPT:
A) The hedge is asymmetric.
B) There is no uncovered exposure remaining.
C) The total position is a perfect hedge.
D) The currency hedge ratio is equal to 1. - ✔✔A) The hedge is asymmetric.
✔✔________ are transactions for which there are, at present, no contracts or
agreements between parties.
A) Backlog exposure
B) Quotation exposure
C) Anticipated exposure
D) none of the above - ✔✔C) Anticipated exposure
✔✔According to a survey by Bank of America, the type of foreign exchange risk most
often hedged by firms is:
A) translation exposure.
B) transaction exposure.
C) contingent exposure.
D) economic exposure. - ✔✔B) transaction exposure.
✔✔________ is the possibility that the borrower's creditworthiness is reclassified by the
lender at the time of renewing credit. ________ is the risk of changes in interest rates
charged at the time a financial contract rate is set.
A) Credit risk; Interest rate risk
B) Repricing risk; Credit risk
C) Interest rate risk; Credit risk
, D) Credit risk; Repricing risk - ✔✔D) Credit risk; Repricing risk
✔✔Some of the world's largest and most financially sound firms may borrow at variable
rates less than LIBOR. - ✔✔TRUUUU
✔✔The London Interbank Offered Rate (LIBOR) is published under the auspices of the
British Bankers Association. A panel of 16 major multinational banks self-report their
actual borrowing rate. - ✔✔FALSE
Explanation: Each day, a panel of 16 major multinational banks is requested to submit
estimated borrowing rates. Rates are based on "estimated borrowing rates" to avoid
reporting only actual transactions - discretionary.
✔✔The basis point spreads between credit ratings dramatically rise for borrowers of
credit qualities less than BBB. - ✔✔TRUE
✔✔The single largest interest rate risk of a firm is:
A) interest sensitive securities.
B) debt service.
C) dividend payments.
D) accounts payable. - ✔✔B) debt service.
✔✔For the following problem(s), consider these debt strategies being considered by a
corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year
period.
∙ Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
∙ Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be
reset annually. The current LIBOR rate is 3.50%
∙ Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit
annually. The current one-year rate is 5%. - ✔✔
✔✔Refer to Instruction 8.1. Choosing strategy #1 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit
and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period. -
✔✔D) preclude the possibility of sharing in lower interest rates over the three-year
period.
✔✔Refer to Instruction 8.1. Choosing strategy #2 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
