Fin 470 – Moore
Exam 3 – 1
Fall 2005
Third Examination – Finance 470 - Conflict
Fall 2005 (Moore)
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Multiple Choice (2 points each): Circle the Best response
1.
In a forward market hedge, a company that is short in a foreign currency will ____
the foreign currency forward or futures contract.
a.
buy
b.
sell
c.
borrow
d.
lend
2. Your company is expecting to receive payment of 12,000,000 Euros from a German client
in 6 months. The chief financial officer, Mo Prophets, is concerned about unfavorable
currency movements but would like to take advantage of favorable exchange rate
movements. Which hedging strategies in the options market would Mo use?
a. Buy a 6 month call option on Euros
b. Sell a 6 month call option on Euros
c. Buy a 6 month put option on Euros
d. Sell a 6 month put option on Euros
3. Which of the following currency hedging strategies does not provide insurance against all
possible unfavorable currency (exchange rate) movements?
a. Simple currency options (use of a single option)
b. Forward contracts on currencies
c. Futures contracts on currencies
d. Currency collars
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Fin 470 – Moore
Exam 3 – 1
Fall 2005
The following information is to be used in answering questions 4-6.
Ajax Manufacturing's Australian subsidiary has the following balance sheet (stated in Australian
Dollars):
Cash, marketable
securities
Accounts receivable
Inventory (at market.
Fixed Assets
250,000
1,000,000
2,700,000
5,100,000
----------------$AU 9,050,000
Current liabilities
Long-term debt
Equity
Total liabilities
plus equity
750,000
3,400,000
4,900,000
--------------$AU 9,050,000
Total assets
Assume the business was shut down for the entire year of 2005 due to a government investigation. As
a result, the above balance sheet reflects both the beginning of the year and end of the year
position for the company since no business activities took place.
4. Suppose the Australian dollar appreciated from 0.6500 ($US/$AU) to 0.7100 ($US/$AU)
during the year. Which of the following statements best reflects the economic gain or
loss one would expect to see when the financial statements are translated back to $US.
a. Ajax had an economic gain on the assets
b. Ajax had an economic loss on the assets
c. Ajax had an economic gain on the liabilities
d. Ajax had an economic loss on the equity
5. Suppose the Australian dollar depreciated from 0.7950 ($US/$AU) to 0.7781 ($US/$AU)
during the year. Which of the following statements best reflects the economic gain or
loss one would expect to see when the financial statements are translated back to $US.
a. Ajax had an economic gain on the assets
b. Ajax had an economic loss on the assets
c. Ajax had an economic gain on the liabilities
d. Ajax had an economic loss on the equity
6. Suppose the Australian dollar depreciated from 0.7950 ($US/$AU) to 0.7781 ($US/$AU)
during the year. Which of the following results from the accounting translation would
be consistent with the underlying economic gains or losses when the financial statements
are translated back to $US.
a. Translation loss under the Monetary/Non-Monetary method
b. Translation gain under the temporal method
c. Translation gain under the current rate method
d. Translation gain under the current/non-current method
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Fin 470 – Moore
Exam 3 – 1
Fall 2005
7.
Ford simultaneously borrows 10,000,000 Mexican pesos at 13%, converts the pesos to $US and
invests dollars at 10%, both for one year. At the time Ford enters into these transactions, the
spot rate for the peso is $0.095. If the spot rate is Peso. 1 = $0.087 in one year, what is the cost
to Ford of this money market hedge?
a. $113,100 Cost (loss)
b. $95,000 Gain
c. $61,900 Gain
d. $10,400 Cost (loss)
8.
During a home currency appreciation, exporters may pull out of markets that foreign competition
makes ________.
a. unprofitable
b. more competitive
c. profitable
d. more liquid
9.
___________ exposure is based on the extent to which the value of the entire firm will change
when exchange rates change.
a.
b.
c.
d.
Translation
Transaction
Economic
Operating
10.
With respect to production management of exchange risk, ________ and plant location are the
principal variables that companies may change to manage the risk.
a. product innovation
b. product retirement
c. market selection
d. product sourcing
11.
A strong (appreciating) dollar will
a. force American exporters to raise their foreign currency prices
b. result in higher dollar costs for American importers
c. enable American exporters to improve their profit margins
d. cost American exporters market share abroad
12.
Which one of the following would be the best response for a U.S. exporter to depreciation of the
dollar?
a. raise the foreign currency price if the dollar depreciation was expected to be temporary and
the cost of regaining market share was minimal
b. reduce production offshore if the depreciation were expected to persist for an extended
period
c. reduce product innovation
d. reduce product mix (eliminate product lines)
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Fin 470 – Moore
Exam 3 – 1
Fall 2005
13.
Suppose Apple is selling Macintosh computers in Germany for DM 5,500 when the exchange
rate is DM 1 = $0.68. If the DM rises to $0.71, what price must Apple charge to maintain its
dollar unit revenue?
a. DM 5,147
b. DM 6,361
c. DM 5,743
d. DM 5,268
14.
One function of the cost of capital is to ________ for the firm.
a. determine the debt to equity ratio
b. value future cash flows
c. determine the current ratio
d. determine the current lending rate
15.
One of the key issues in estimating foreign project betas is to find firms that are publicly traded
that share _____ risk characteristics when compared to the project.
a. different
b. somewhat different
c. uncorrelated
d. similar
16.
Suppose that a foreign project has a beta of 1.25, the risk-free return is 4.5% and the market risk
premium estimated at 8%. Then the cost of equity capital for the project is
a. 14.500%
b. 8.875%
c. 10.000%
d. 3.500%
17.
Assume an average dividend payout rate of 100% for both U.S. and German companies. Suppose
the average P/E ratio for German firms is 16 and 20 for U.S. firms. Based on the dividend
growth model, in order for German and U.S. companies to have the same average cost of equity
capital, what is the difference between the German and US annual earnings growth rate have to
be? Recall,
P0 
a.
b.
c.
d.
1.25% higher in Germany
5% higher in the US
7.5% higher in the US
7.5% higher in Germany
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D1
ke  g
Fin 470 – Moore
Exam 3 – 1
Fall 2005
18.
In computing a company’s after-tax weighted average cost of capital, which of the following is
not used as an input?
a. Market value of Equity
b. Book Value of Equity
c. The average tax rate
d. Market value of the firm’s assets
19.
Your are given the following information: Cost of Equity = 24%; Cost of Debt = 9%; Tax Rate
= 30%. The firm’s target D/E = 2 (based on market values). Compute after-tax WACC. Recall:
WACC AT 
a.
b.
c.
d.
20.
VE
V
k e  D k D (1  T )
VF
VF
10.45%
12.20%
14.00%
23.00%
Suppose the Euro franc is expected to appreciate against the dollar by 3% annually and the 10year Euro interest rate is 7%. What is the after-tax expected dollar cost of issuing a 10-year
Euro bond if the appropriate Euro corporate tax rate is 40%?
a. 10.21%
b. 7.326%
c. 3.8835%
d. 1.165%
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Fin 470 – Moore
Exam 3 – 1
Fall 2005
Problem 1 (20 Points) Show all Work
You are due to receive payment of 12,500,000 Euros in June 2006 from a French customer.
The current spot exchange rate is $1.1716 per Euro. You are concerned about currency
fluctuations over the next 7 months and want to hedge this future cash inflow using a
currency collar. You are long Euros and are most concerned about the Euro depreciating
against the dollar over this time period. Hence, you want to have insurance against price
exchange rate movements outside the $1.170 per Euro and $1.260 per Euro range
Each Euro option contract on the CME covers 125,000 Euros. The following bid-ask quotes
have been provided by the CME:
Call Options:
Exercise Price
1.170
1.260
Bid
$6,275
$1,250
Ask
$6,750
$1,875
Ex. Price
1.170
1.260
Put Options:
Bid
$2,787.50
$9,587.50
Ask
$3,100
$10,025
The appropriate currency collar involves a long put and a short call option.
Required:
1. Graph the currency collar. Be sure to label the appropriate exercise points. Identify the
Call and put option components and the profit/loss regions.
2. Ignoring transaction costs, compute the initial cost of implementing the collar.
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Fin 470 – Moore
Exam 3 – 1
Fall 2005
Problem 2 (20 Points) Show all Work
Consider a project that costs $2 million today but yields no returns for several years. Once the project
becomes productive, it yields $350,000 annually forever. Suppose two firms are examining this project,
an Irish firm with a cost of capital of 8% and a U.S. firm with a cost of capital of 12%.
1. What is the maximum number of years the Irish firm can wait before the project begins generating
the cash flows and still make it a positive NPV project? (use continuous compounding)
2. What is the maximum number of years the US firm can wait before the project begins generating the
cash flows and still make it a positive NPV project? (use continuous compounding)
3. Which of the two firms can be more patient in waiting for the cash flows to begin? By how many
years?
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Fin 470 – Moore
Exam 3 – 1
Fall 2005
Problem 3 (20 Points) Essay
Discuss and differentiate transaction hedging strategies with Futures, single options, and
collars that use a combination of puts and calls.
Identify how much risk is being insured (both up and downside vs. only all downside vs. part
of upside and part of downside). Discuss the relative costs associated with the three types of
strategies. Make sure you distinguish how the strategies differ when you are long or short in
the underlying currency.
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