Tutorial+solutions+Week+9

Tutorial+solutions+Week+9 - Chapter 10 Managing Transaction...

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Chapter 10 Managing Transaction Exposure to Currency Risk Answers to Conceptual Questions 10.1 What is transaction exposure to currency risk? Transaction exposure is change in the value of monetary (contractual) cash flows due to an unexpected change in exchange rates. 10.2 What is a risk profile? A risk profile graphically displays change in the value of an underlying currency exposure to change in the value of the underlying currency, such as Δ V d/f as a function of Δ S d/f . Risk profiles can be displayed in levels or in changes in levels. 10.3 In what ways can diversified multinational operations provide a natural hedge of transaction exposure to currency risk? Geographically diversified multinational corporations have relatively low transaction exposure to currency risk when they have cash inflows and outflows in a wide variety of currencies. Geographically diversified operations provide opportunities to reduce the multinational corporation’s currency risk exposures through multinational netting and leading and lagging of intracompany transactions. 10.4 What is multinational netting? Why is it used by multinational corporations? In multinational netting, a corporation’s exposure to currency risk is found by consolidating and then netting the exposures of individual assets and liabilities. Multinational netting reduces the transactions costs of hedging individual currency risk exposures in external financial markets. 10.5 What is leading and lagging? Why is it used by multinational corporations? Leading and lagging is a way to reduce the firm’s transaction exposure by altering the timing of cash flows within the corporation. Like multinational netting, leading and lagging works best when the currency needs of the individual units within the corporation offset one another. 10.6 Define each of the following: a) currency forwards, b) currency futures, c) currency options, d) currency swaps, and e) money market hedges. Currency forwards are contracts for future delivery according to an agreed-upon delivery date, exchange rate, and amount. Exchange-traded currency futures contracts are similar to forwards except that changes in value are settled daily as the two sides of the contract are marked-to-market. A currency option contract gives the option holder the right to buy or sell an underlying currency at a specified price and on a specified date. A currency swap is a contractual agreement to exchange a principal amount of two different currencies and, after a prearranged length of time, to give back the original principal. A money market hedge replicates a currency forward contract through the spot currency and Eurocurrency markets. 10.7 What is a currency cross-hedge? Why might it be used? A currency cross-hedge uses a currency that is different from, but closely related to, the
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Tutorial+solutions+Week+9 - Chapter 10 Managing Transaction...

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