CFC International Financial Management 2 — Questions and Answers
Question 1: A US company has a €5 million payable due in 90 days. To hedge using a forward contract, the company should:
- Sell euros forward
- Buy euros forward (Correct answer)
- Buy US dollars forward
- Sell US dollars in the spot market
Correct answer: Buy euros forward
To hedge a euro payable, the company buys euros forward, locking in the exchange rate and eliminating currency risk.
Question 2: The International Fisher Effect (IFE) states that:
- Interest rate differentials equal inflation rate differentials
- Exchange rate changes are proportional to nominal interest rate differentials between countries (Correct answer)
- Spot rates equal forward rates in efficient markets
- Real interest rates are equal across countries after adjusting for inflation
Correct answer: Exchange rate changes are proportional to nominal interest rate differentials between countries
The IFE holds that currencies of countries with higher nominal interest rates will depreciate by the amount of the interest rate differential.
Question 3: Which of the following best describes 'translation exposure' in multinational corporations?
- Risk from converting foreign currency transactions at different spot rates
- Risk arising from consolidating foreign subsidiaries' financial statements into the parent's reporting currency (Correct answer)
- Risk that future cash flows will change due to exchange rate movements
- Risk from cross-currency interest rate swaps
Correct answer: Risk arising from consolidating foreign subsidiaries' financial statements into the parent's reporting currency
Translation exposure (accounting exposure) arises when consolidating foreign subsidiaries' statements into the parent company's home currency.
Question 4: A country running a persistent current account deficit will most likely experience:
- Currency appreciation due to higher export demand
- Currency depreciation due to excess supply of domestic currency in forex markets (Correct answer)
- Stable exchange rates if capital flows are balanced
- Rising foreign exchange reserves
Correct answer: Currency depreciation due to excess supply of domestic currency in forex markets
A persistent current account deficit means more domestic currency is sold to buy foreign goods, creating downward pressure on the currency.
Question 5: Under ASC 830 (formerly SFAS 52), which method is used to translate a foreign subsidiary that operates as a self-contained entity?
- Temporal method
- Current rate method (Correct answer)
- Monetary/non-monetary method
- Historical rate method
Correct answer: Current rate method
The current rate method translates all balance sheet items at the current exchange rate and is used when the subsidiary's functional currency differs from the parent's reporting currency.
Question 6: A US exporter invoices a Japanese client in USD. Which party bears the transaction exchange rate risk?
- The US exporter, because it must convert USD to JPY
- The Japanese importer, because it must acquire USD to pay the invoice (Correct answer)
- Both parties share the risk equally
- Neither party, since USD is the invoice currency
Correct answer: The Japanese importer, because it must acquire USD to pay the invoice
The Japanese importer bears the risk because it must exchange yen for US dollars, and if the yen weakens, the cost increases.
Question 7: The primary purpose of a currency swap is to:
- Speculate on short-term exchange rate movements
- Exchange principal and interest payments in one currency for those in another currency (Correct answer)
- Eliminate inflation risk on foreign investments
- Convert fixed-rate debt to floating-rate debt in the same currency
Correct answer: Exchange principal and interest payments in one currency for those in another currency
A currency swap involves exchanging both principal and periodic interest payments in one currency for equivalent payments in another currency over a set term.
CFC International Financial Management 2
A US company has a €5 million payable due in 90 days.
To hedge using a forward contract, the company should: