Exam 2 Sample Questions FINAN430 International Finance McBrayer Spring 2018

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1 Sample Multiple Choice Questions 1. Suppose you observe a spot exchange rate of $1.0500/. If interest rates are 5% APR in the U.S. and 3% APR in the euro zone, what is the no-arbitrage 1-year forward rate? a /$ b. $1.0704/ c /$ d. $1.0300/ 2. Suppose that the one-year interest rate is 3.0 percent in Italy, the spot exchange rate is $1.20/, and the one-year forward exchange rate is $1.18/. What must the one-year interest rate be in the United States to avoid arbitrage? a % b % c. 4.75% 3. Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and the one-year forward exchange rate is $1.16/. What must the spot exchange rate be? a. $1.1768/ b. $1.1434/ c. $1.12/ 4. A higher U.S. interest rate (i$ ) relative to interest rates abroad, ceteris paribus, will result in a. a stronger dollar. b. a lower spot exchange rate (expressed as foreign currency per U.S. dollar). c. a stronger dollar and a lower spot exchange rate (expressed as foreign currency per U.S. dollar). 5. If the interest rate in the U.S. is i$ = 5 percent for the next year and interest rate in the U.K. is i = 8 percent for the next year, uncovered IRP suggests that a. the pound is expected to depreciate against the dollar by about 3 percent. b. the pound is expected to appreciate against the dollar by about 3 percent. c. the dollar is expected to appreciate against the pound by about 3 percent. d. the pound is expected to depreciate against the dollar by about 3 percent and the dollar is expected to appreciate against the pound by about 3 percent. 6. A currency dealer has good credit and can borrow either $1,000,000 or 800,000 for one year. The one-year interest rate in the U.S. is i$ = 2% and in the euro zone the one-year interest rate is i = 6%. The one-year forward exchange rate is $1.20 = 1.00; what must the spot rate be to eliminate arbitrage opportunities? a. $ = 1.00 b. $1.20 = 1.00 c. $ = 1.00 Page 1

2 7. As of today, the spot exchange rate is 1.00 = $1.25 and the rates of inflation expected to prevail for the next year in the U.S. is 2 percent and 3 percent in the euro zone. What is the one-year forward rate that should prevail? a = $ b = $ c = $ d. $1.00 = If you think that the dollar is going to appreciate against the euro, you should a. buy put options on the euro. b. buy call options on the euro. c. buy call options on the dollar. d. buy put options on the dollar. 9. From the perspective of the buyer of a put option written on 62,500. If the strike price is $1.55/, and the option premium is $0.03 per euro, at what exchange rate do you start to make money? a. $1.50/ b. $1.52/ c. $1.55/ d. $1.58/ 10. A European option is different from an American option in that a. one is traded in Europe and one in traded in the United States. b. European options can only be exercised at maturity; American options can be exercised prior to maturity. c. European options tend to be worth more than American options, ceteris paribus. d. American options have a fixed exercise price; European options' exercise price is set at the average price of the underlying asset during the life of the option. 11. The current spot exchange rate is $1.55 = 1.00 and the three-month forward rate is $1.60 = Consider a three-month American call option on 62,500. For this option to be considered at-themoney, the strike price must be a. $1.60 = 1.00 b. $1.55 = 1.00 c. $1.50 = Transaction exposure is best defined as a. the sensitivity of realized domestic currency values of the firm's contractual cash flows denominated in foreign currencies to unexpected exchange rate changes. b. the extent to which the value of the firm would be affected by unanticipated changes in exchange rate. c. the potential that the firm's consolidated financial statement can be affected by changes in exchange rates. d. ex post and ex ante currency exposures. 13. If you owe a foreign currency denominated debt, you can hedge with a. a long position in a currency forward contract. b. a long position in an exchange-traded futures contract. c. buying the foreign currency today and investing it in the foreign county. d. All of the above Page 2

3 14. The extent to which the value of the firm would be affected by unexpected changes in the exchange rate is a. transaction exposure. b. translation exposure. c. economic exposure. 15. Exchange rate risk of a foreign currency payable is an example of a. transaction exposure. b. translation exposure. c. economic exposure. 16. Your firm has a British customer that is willing to place a $1 million order, but wants to pay in pounds instead of dollars. The spot exchange rate is $1.85 = 1.00 and the one-year forward rate is $1.90 = The lead time on the order is such that payment is due in one year. What is the fairest exchange rate to use? a. $1.85 = 1.00 b. $ = 1.00 c. $1.90 = Buying a currency option provides a. a flexible hedge against exchange exposure. b. limits the downside risk while preserving the upside potential. c. a right, but not an obligation, to buy or sell a currency. d. all of the options 18. A U.S. firm has sold an Italian firm 1,000,000 worth of product. In one year the U.S. firm gets paid. To hedge, the U.S. firm bought put options on the euro with a strike price of $1.65. They paid an option premium $0.01 per euro. If at maturity, the exchange rate is $1.60, a. the firm will realize $1,145,000 on the sale net of the cost of hedging. b. the firm will realize $1,150,000 on the sale net of the cost of hedging. c. the firm will realize $1,140,000 on the sale net of the cost of hedging. 19. XYZ Corporation, located in the United States, has an accounts payable obligation of 750 million payable in one year to a bank in Tokyo. Which of the following is not part of a money market hedge? a. Buy the 750 million at the forward exchange rate. b. Find the present value of 750 million at the Japanese interest rate. c. Buy that much yen at the spot exchange rate. d. Invest in risk-free Japanese securities with the same maturity as the accounts payable obligation. Page 3

4 20. XYZ Corporation, located in the United States, has an accounts payable obligation of 750 million payable in one year to a bank in Tokyo. The current spot rate is 116/$1.00 and the one year forward rate is 109/$1.00. The annual interest rate is 3 percent in Japan and 6 percent in the United States. XYZ can also buy a one-year call option on yen at the strike price of $ per yen for a premium of cent per yen. The future dollar cost of meeting this obligation using the money market hedge is a. $6,450,000. b. $6,545,400. c. $6,653,833. d. $6,880, To hedge a foreign currency receivable, a. buy call options on the foreign currency with a strike in the domestic currency. b. buy put options on the foreign currency with a strike in the domestic currency. c. sell call options on the foreign currency with a strike in the domestic currency. d. sell put options on the foreign currency with a strike in the domestic currency. 22. Your U.S. firm has a 100,000 payable with a 3-month maturity. Which of the following will hedge your liability? a. Buy a call option on 100,000 with a strike price in euro. b. Buy a put option on 100,000 with a strike price in dollars. c. Buy a call option on 100,000 with a strike price in dollars. 23. Your U.S. firm has a 100,000 payable with a 3-month maturity. Which of the following will hedge your liability? a. Buy the present value of 100,000 today at the spot exchange rate, invest in the U.K. at i. b. Buy a call option on 100,000 with a strike price in dollars. c. Take a long position in a forward contract on 100,000 with a 3-month maturity. d. all of the options 24. An exporter can shift exchange rate risk to their customers by a. invoicing in the home currency of the exporter. b. invoicing in the customer's local currency. c. splitting the difference, and invoicing half of sales in the customer's local currency and half of sales in home currency of the exporter. d. invoicing sales in a currency basket such as the SDR as the invoice currency. In-Class Quiz Questions 25. If the price of a book in the U.S. is USD10 and the same book in Mexico costs MXN90. What should be the cost of dollars in terms of pesos LoOP holds? a. USD 0.10 b. USD 0.11 c. MXN 9 d. USD Continued from previous...if the inflation rate in the U.S. is expected to be 4% over the year and the inflation rate in Mexico is expected to be 6%, what should be the cost of dollars in terms of pesos at the end of the year? a. MXN 9.17 b. MXN c. USD 9.17 Page 4

5 d. USD Suppose that the current dollar to pound spot rate is USD If the 180-day forward rate is USD1.672, what is the forward rate discount? a % b % c % d. Cannot tell from the information given 28. On average, it easier for an MNC to get out of a forward contract compared to a futures contract. a. True b. False 29. If a speculator thought that the spot rate of a currency was going to decline significantly over the next year, then buying a option on the currency would be the prudent investment. a. Put b. Call 30. Suppose that an investor expects the USD/EUR spot rate to increase. Which of the following derivatives would be most appropriate to profit from the decline? a. Long call option on USD b. Long call option on EUR c. Long put option on EUR d. Short call option on EUR 31. If the spot price of a currency falls below the strike price on a call option, then that option is said to be. a. In-the-money b. Out-of-the-money c. At-the-money 32. Using the VaR approach to estimate transaction exposure, what is the max 1-day loss faced by an MNC if they expected a no change in the currency value over the next month, the daily standard deviation of currency values is 3%, and they wanted a 95% confidence interval (i.e., z-score of 1.65)? a. 1.65% b. 3% c. 4.95% 33. If the spot rate of GBP/EUR is GBP If interest rates are 5% APR in Britain and 3% in the euro zone, what is the 1-year forward rate assuming no arbitrage? a. GBP b. GBP c. GBP d. GBP Suppose that a U.S. based MNC expects to pay EUR 200,000,000 in a year. If the firm wanted to use a money market hedge and it could invest to earn 5% on a euro-denominated investment over the year, how many euros does the firm need today (round to the nearest euro)? a. EUR 185,632,947 b. EUR 190,476,191 c. EUR 200,000,000 d. EUR 210,000,000 Page 5

6 ANSWER KEY: Sample Multiple Choice Questions 1. B 2. A 3. B 4. A 5. D 6. A 7. A 8. C 9. B 10. B 11. B 12. A 13. D 14. C 15. A 16. C 17. D 18. D 19. A 20. C 21. B 22. C 23. D 24. A In-Class Quiz Questions 25. C 26. A 27. C 28. B 29. A 30. B 31. B 32. C 33. A 34. B Page 6