THE UNIVERSITY OF THE WEST INDIES, MONA
DEPARTMENT OF ECONOMICS
ECON3007 (EC30P): INTERNATIONAL FINANCE
Tutorial Paper 4 – Foreign Exchange Risk
Question 1
a) Distinguish between translation exposure, transaction exposure and
economic exposure.
b) Discuss the advantages and disadvantages of:
(i) Foreign currency forward contracts;
(ii)Foreign currency futures contracts:
(iii) Foreign currency options
(iv) Foreign exchange swap
Question 2
a) Carefully explain how each of the following is used to hedge foreign exchange
risk.
i)
Speeding (slowing) payments of currencies expected to appreciate
(depreciate).
ii)
Speeding (slowing) collection of currencies expected to depreciate
(appreciate).
b) i) Does an efficient foreign exchange market rule out all opportunities for
speculative profits? Explain your answer.
ii) If foreign stock markets are efficient, why should this allow us to buy foreign
stocks as safely as we buy domestic stocks?
Question 3
a) Assume that the Spot rate is US2/UK and the three-month forward rate is
US1.96/UK. Carefully explain, how an importer who will have to pay
UK10,000 in three months can hedge the foreign exchange risk?
b) Briefly answer the following questions.
(i)
Explain the similarities and differences between the forward and
futures markets
(ii)
Why might you prefer an option to a futures or forward contract?
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