CFC International Financial Management 4 — Questions and Answers
Question 1: Under the temporal method of foreign currency translation, monetary assets are translated at:
- Historical exchange rates prevailing when acquired
- The current (closing) exchange rate at the balance sheet date (Correct answer)
- The average exchange rate for the reporting period
- Forward rates for the next reporting period
Correct answer: The current (closing) exchange rate at the balance sheet date
Under the temporal method, monetary assets (cash, receivables, debt) are translated at the current rate, while non-monetary assets use historical rates.
Question 2: A European company wants to borrow in US dollars but prefers euro-denominated debt. A US company faces the opposite preference. They agree to a currency swap. What does this arrangement allow each company to achieve?
- Both companies borrow in their preferred currency while effectively accessing the other currency's market rates (Correct answer)
- Both companies speculate on the dollar/euro exchange rate
- Only the European company benefits by avoiding currency risk
- Both companies pay the same interest rate regardless of market conditions
Correct answer: Both companies borrow in their preferred currency while effectively accessing the other currency's market rates
A currency swap enables each party to borrow in the market where it has a comparative advantage, then swap the proceeds, achieving preferred-currency financing at potentially better rates.
Question 3: The 'J-curve effect' in international economics describes:
- The tendency for trade deficits to worsen initially before improving after a currency depreciation (Correct answer)
- The positive correlation between FDI inflows and exchange rate appreciation
- The gradual improvement in export quality following trade liberalization
- The relationship between interest rates and capital inflows
Correct answer: The tendency for trade deficits to worsen initially before improving after a currency depreciation
After depreciation, trade volumes are slow to adjust due to existing contracts, so the trade balance worsens initially before improving as exports rise and imports fall.
Question 4: Which transfer pricing method uses gross profit margins of comparable uncontrolled transactions to set intercompany prices?
- Comparable Uncontrolled Price (CUP) method
- Resale Price method (Correct answer)
- Cost Plus method
- Transactional Net Margin method (TNMM)
Correct answer: Resale Price method
The Resale Price method applies the gross profit margin earned by comparable independent distributors to set the intercompany transfer price.
Question 5: A foreign subsidiary's functional currency is the same as the parent's reporting currency. Under ASC 830, which translation method applies?
- Current rate method
- Temporal method (Correct answer)
- Average rate method
- Fair value method
Correct answer: Temporal method
When a foreign entity's functional currency is the same as the parent's reporting currency, the temporal method (remeasurement) is used under ASC 830.
Question 6: The Mundell-Fleming model predicts that under a fixed exchange rate regime with perfect capital mobility, fiscal policy is:
- Ineffective because interest rate changes are offset by capital outflows
- Highly effective because the money supply adjusts to maintain the fixed rate (Correct answer)
- Ineffective because the central bank sterilizes all fiscal stimulus
- Effective only in the short run before inflation erodes the gains
Correct answer: Highly effective because the money supply adjusts to maintain the fixed rate
With a fixed exchange rate and perfect capital mobility, fiscal expansion raises demand without crowding out investment, as the central bank expands money supply to hold the exchange rate.
Question 7: An options-based hedge using a put option on a foreign currency provides protection when the foreign currency:
- Appreciates, increasing the value of the receivable
- Depreciates, reducing the home-currency value of the receivable (Correct answer)
- Remains stable, providing only premium savings
- Appreciates above the strike price, triggering the option
Correct answer: Depreciates, reducing the home-currency value of the receivable
A put option gives the right to sell the foreign currency at the strike price, protecting a foreign currency receivable if the foreign currency depreciates below the strike.
CFC International Financial Management 4
Under the temporal method of foreign currency translation, monetary assets are translated at: