Podcast
Questions and Answers
What defines transaction exposure?
What defines transaction exposure?
- Long-term fluctuations in exchange rates that affect firm value
- The impact of trade volumes on foreign exchange markets
- Sensitivity of domestic currency values to exchange rate changes (correct)
- Fixed-price contracts that are immune to exchange rate changes
At what future spot rate does the options hedge begin to dominate the money market hedge?
At what future spot rate does the options hedge begin to dominate the money market hedge?
- $1.4813/£ (correct)
- $1.4812/£
- $1.4820/£
- $1.4800/£
What is the break-even spot rate at which Boeing is indifferent between the two hedging methods?
What is the break-even spot rate at which Boeing is indifferent between the two hedging methods?
- $1.4790/£
- $1.4813/£ (correct)
- $1.4825/£
- $1.4800/£
Why is transaction exposure considered a short-term economic exposure?
Why is transaction exposure considered a short-term economic exposure?
How does transaction exposure primarily affect multinational corporations (MNCs)?
How does transaction exposure primarily affect multinational corporations (MNCs)?
What does the left side of the equation for break-even spot rate represent?
What does the left side of the equation for break-even spot rate represent?
What is economic exposure primarily concerned with?
What is economic exposure primarily concerned with?
When is the money market hedge preferred over the options hedge?
When is the money market hedge preferred over the options hedge?
What differentiates transaction exposure from translation exposure?
What differentiates transaction exposure from translation exposure?
Which of the following best describes translation exposure?
Which of the following best describes translation exposure?
What factors are considered in calculating the dollar proceeds of the options hedge?
What factors are considered in calculating the dollar proceeds of the options hedge?
If the future spot rate is $1.4800/£, which hedging strategy is more advantageous?
If the future spot rate is $1.4800/£, which hedging strategy is more advantageous?
What does it mean when it is said that economic exposure accounts for unanticipated changes?
What does it mean when it is said that economic exposure accounts for unanticipated changes?
In what context is transaction exposure usually discussed?
In what context is transaction exposure usually discussed?
Which of the following equations represents the break-even point for the hedging methods?
Which of the following equations represents the break-even point for the hedging methods?
What is a key characteristic of the options hedge compared to the money market hedge?
What is a key characteristic of the options hedge compared to the money market hedge?
What does S represent in the equation S T > F?
What does S represent in the equation S T > F?
In the first scenario, what happens to the expected gains or losses when S is approximately equal to F?
In the first scenario, what happens to the expected gains or losses when S is approximately equal to F?
What does forward hedging primarily eliminate for the firm?
What does forward hedging primarily eliminate for the firm?
Under what condition is the scenario where S is approximately equal to F considered valid?
Under what condition is the scenario where S is approximately equal to F considered valid?
What is expected from the firm when S is less than F in the second scenario?
What is expected from the firm when S is less than F in the second scenario?
What does the second scenario suggest about the firm's management perspective?
What does the second scenario suggest about the firm's management perspective?
What is a potential motivational factor for the firm to hedge in the first scenario?
What is a potential motivational factor for the firm to hedge in the first scenario?
If a firm anticipates a future gain from forward hedging, what does that imply about the relationship between S and F?
If a firm anticipates a future gain from forward hedging, what does that imply about the relationship between S and F?
How much did Boeing need to borrow to match their pound receivable?
How much did Boeing need to borrow to match their pound receivable?
What was the spot exchange rate used for converting pounds into dollars?
What was the spot exchange rate used for converting pounds into dollars?
What is the maturity value of the dollar investment after one year?
What is the maturity value of the dollar investment after one year?
What amount is Boeing expected to collect from British Airways after one year?
What amount is Boeing expected to collect from British Airways after one year?
What does the net cash flow at the present time imply about the money market hedge?
What does the net cash flow at the present time imply about the money market hedge?
After borrowing the amount, what was the first action taken by Boeing?
After borrowing the amount, what was the first action taken by Boeing?
What interest rate was assumed for the dollar investment in the United States?
What interest rate was assumed for the dollar investment in the United States?
What is the total amount that Boeing will repay at the end of the loan period?
What is the total amount that Boeing will repay at the end of the loan period?
What factor complicates the exact hedging process for firms using futures contracts?
What factor complicates the exact hedging process for firms using futures contracts?
Which statement accurately describes how a firm can hedge transaction exposure?
Which statement accurately describes how a firm can hedge transaction exposure?
How can a company like Boeing eliminate currency exchange exposure in foreign sales?
How can a company like Boeing eliminate currency exchange exposure in foreign sales?
What must happen on the maturity date of a loan used for hedging?
What must happen on the maturity date of a loan used for hedging?
What is one outcome of interim cash flows in a futures contract?
What is one outcome of interim cash flows in a futures contract?
Which best describes a money market hedge?
Which best describes a money market hedge?
What is the primary reason for a firm to hedge transaction exposure?
What is the primary reason for a firm to hedge transaction exposure?
What does a firm achieve by making the maturity value of a loan equal to its foreign receivable?
What does a firm achieve by making the maturity value of a loan equal to its foreign receivable?
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Study Notes
Money Market vs Options Hedge
- The options hedge dominates the money market hedge for future spot rates greater than $1.4813/£
- The money market hedge dominates the options hedge for future spot rates lower than $1.4813/£
- Both hedging methods result in the same dollar proceeds at the break-even spot rate of $1.4813/£
Transaction Exposure
- Transaction exposure is the sensitivity of a firm's realized domestic currency values of contractual cash flows to unexpected exchange rate changes.
- This type of exposure affects the amount of money a firm owes or expects to receive in foreign currency, particularly for exporters and importers.
- It is also considered a short-term economic exposure because it impacts the firm's domestic currency cash flows.
- Transaction exposure arises from fixed-price contracting in a world with fluctuating exchange rates.
Forward Hedging
- Forward hedging eliminates exchange exposure while potentially sacrificing expected dollar proceeds.
- The forward exchange rate is an unbiased predictor of the future spot rate in most cases.
- Hedging is beneficial when a company is risk-averse and expected dollar proceeds are approximately zero.
- Under the second scenario, where the expected future spot exchange rate is less than the forward rate, the firm anticipates a positive gain from forward hedging.
Money Market Hedge
- This strategy involves borrowing and lending in domestic and foreign money markets to hedge against transaction exposure.
- Firms borrow in foreign currency to hedge receivables and lend in foreign currency to hedge payables.
- In the example provided, Boeing borrows £9,174,312 at an interest rate of 9% to eliminate its pound exposure.
- The borrowed amount is converted to dollars at the current spot rate and invested at a dollar interest rate of 6.1%.
- The firm receives the maturity value of the dollar investment, ensuring the guaranteed dollar proceeds from the British sale.
- This method is self-financing as the maturity value offsets the borrowed amount.
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