Multinational Business Finance, 13e (Eiteman/Stonehill/Moffett)

Chapter 12 Operating Exposure

12.1 Trident Corporation: A Multinational's Operating Exposure

Multiple Choice

1) Another name for operating exposure is ________ exposure.

A) economic
B) competitive
C) strategic
D) all of the above
Answer: D
Diff: 1
Topic: 12.1 Trident Corporation: A Multinational's Operating Exposure
Skill: Recognition

2) What type of international risk exposure measures the change in present value of a firm
resulting from changes in future operating cash flows caused by any unexpected change in
exchange rates?
A) transaction exposure
B) accounting exposure
C) operating exposure
D) translation exposure
Answer: C
Diff: 1
Topic: 12.1 Trident Corporation: A Multinational's Operating Exposure
Skill: Recognition

3) ________ cash flows arise from intracompany and intercompany receivables and payments,
while ________ cash flows are payments for the use of loans and equity.
A) Financing; operating
B) Operating; financing
C) Operating; accounting
D) Accounting; financing
Answer: B
Diff: 2
Topic: 12.1 Trident Corporation: A Multinational's Operating Exposure
Skill: Recognition

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4) Which of the following is NOT an example of a financial cash flow?
A) parent invested equity capital
B) interest on intrafirm lending
C) payment for goods and services
D) intrafirm principal payments
Answer: C
Diff: 2
Topic: 12.1 Trident Corporation: A Multinational's Operating Exposure
Skill: Recognition

5) Which of the following is NOT an example of an operating cash flow?

A) management fees and distributed overhead
B) royalties and license fees
C) rent and lease payments
D) dividend paid to parent company
Answer: D
Diff: 2
Topic: 12.1 Trident Corporation: A Multinational's Operating Exposure
Skill: Recognition

6) ________ exposure is far more important for the long-run health of a business than changes
caused by ________ or ________ exposure.
A) Operating; translation; transaction
B) Transaction; operating; translation
C) Accounting; translation; transaction
D) Translation; operating; transaction
Answer: A
Diff: 2
Topic: 12.1 Trident Corporation: A Multinational's Operating Exposure
Skill: Conceptual

7) Simpson Sign Company based in Frostbite Falls, Minnesota has a 6-month C$100,000
contract to complete sign work in Winnipeg, Manitoba, Canada. The current spot rate is
$1.02/C$ and the forward rate is $1.01/C$. Under conditions of equilibrium, management would
use ________ today when preparing operating budgets.
A) $102,000
B) $101,000
C) $100,000
D) none of the above
Answer: B
Diff: 3
Topic: 12.1 Trident Corporation: A Multinational's Operating Exposure
Skill: Analytical

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8) When considering the phases of adjustment and response to operating exposure in the LONG
RUN, price changes tend to be ________ and volume changes tend to be ________.
A) fixed/contracted; contracted.
B) fixed/contracted; completely flexible.
C) completely flexible; completely flexible.
D) completely flexible; contracted.
Answer: C
Diff: 2
Topic: 12.1 Trident Corporation: A Multinational's Operating Exposure
Skill: Conceptual

True/False

1) The goal of operating exposure analysis is to identify strategic operating techniques the firm
might adopt to enhance value in the face of unanticipated exchange rate changes.
Answer: TRUE
Diff: 1
Topic: 12.1 Trident Corporation: A Multinational's Operating Exposure
Skill: Conceptual

2) Operating cash flows may occur in different currencies and at different times, but financing
cash flows may occur only in a single currency.
Answer: FALSE
Comment: Financing of cash flows may also be in several currencies.
Diff: 1
Topic: 12.1 Trident Corporation: A Multinational's Operating Exposure
Skill: Recognition

3) Expected changes in foreign exchange rates should already be factored into anticipated
operating results by management and investors.
Answer: TRUE
Diff: 1
Topic: 12.1 Trident Corporation: A Multinational's Operating Exposure
Skill: Conceptual

4) Moral hazard may occur when a firm or individual takes on more risk when it knows that
someone else will "pick up the tab."
Answer: TRUE
Diff: 1
Topic: 12.1 Trident Corporation: A Multinational's Operating Exposure
Skill: Recognition

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5) Even though contracts are often fixed in the short run, as time passes, prices and costs can be
changed to reflect the new competitive realities caused by a change in exchange rates.
Answer: TRUE
Diff: 1
Topic: 12.1 Trident Corporation: A Multinational's Operating Exposure
Skill: Conceptual

12.2 Measuring Operating Exposure: Trident Germany

Multiple Choice

1) Recently the British Pound suffered an unexpected depreciation in value. Which of the
following actions being considered by Coventry Furniture of London, a purely domestic
furniture manufacturer and retailer, would be considered a highly unlikely response to the
depreciation of the pound?
A) Coventry might choose to maintain its domestic sales prices constant in pound terms.
B) Coventry might try to raise domestic prices because competing imports are now priced higher
in England.
C) Coventry might try to lower domestic prices because competing imports are now priced
higher in England.
D) none of the above
Answer: C
Diff: 2
Topic: 12.2 Measuring Operating Exposure: Trident Germany
Skill: Recognition

2) Recently the Canadian dollar realized an unexpected appreciation in value. Which of the
following actions being considered by Tall Timber Exports, a Canadian logging firm specializing
in exporting raw forest products, would be considered a highly unlikely response to the
appreciation of the Canadian dollar?
A) Tall Timber Exports might lower export prices in an effort to maintain market share.
B) Tall Timber Exports might raise export prices only slightly in an effort to increase market
share.
C) Tall Timber Exports might leave export prices as they are and wait to determine what actions
to take if any in the future.
D) all of the above
Answer: B
Diff: 2
Topic: 12.2 Measuring Operating Exposure: Trident Germany
Skill: Recognition

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3) For a firm that competes internationally to sell its products, a depreciation of its domestic
currency relative to markets where the firm exports goods, should eventually result in ________
sales at home and ________ sales abroad, other things equal.
A) fewer; greater
B) fewer; fewer
C) greater; greater
D) greater; fewer
Answer: C
Diff: 2
Topic: 12.2 Measuring Operating Exposure: Trident Germany
Skill: Conceptual

4) Brimmo Motorcycles Inc., a U.S.-based firm, manufactures and sells electric motorcycles both
domestically and internationally. A sudden and unexpected appreciation of the U.S. dollar should
allow sales to ________ at home and ________ abroad. (Assume other factors remain
unchanged.)
A) increase; increase
B) decrease; decrease
C) increase; decrease
D) decrease; increase
Answer: B
Diff: 2
Topic: 12.2 Measuring Operating Exposure: Trident Germany
Skill: Conceptual

True/False

1) The strategy management undertakes in response to unexpected changes in exchange rates

depends to a large measure on their opinion about the price elasticity of demand.
Answer: TRUE
Diff: 1
Topic: 12.2 Measuring Operating Exposure: Trident Germany
Skill: Recognition

2) Unexpected changes in exchange rates is never good news for a firm's operating income.
Answer: FALSE
Diff: 1
Topic: 12.2 Measuring Operating Exposure: Trident Germany
Skill: Conceptual

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12.3 Strategic Management of Operating Exposure

Multiple Choice

1) Which of the following is NOT an example of diversifying operations?

A) diversifying sales
B) diversifying location of operations
C) raising funds in more than one country
D) sourcing raw materials in more than one country
Answer: C
Diff: 2
Topic: 12.3 Strategic Management of Operating Exposure
Skill: Recognition

2) Which of the following is NOT an example of diversification in financing?

A) raising funds in more than one market
B) raising funds in more than one country
C) diversifying sales
D) All of the above qualify.
Answer: C
Diff: 2
Topic: 12.3 Strategic Management of Operating Exposure
Skill: Recognition

3) When disequilibria in international markets occur, management can take advantage by:
A) doing nothing if they are already diversified and able to realize beneficial portfolio effects.
B) recognizing disequilibria faster than purely domestic competitors.
C) shifting operational of financing activities to take advantage of the disequilibria.
D) all of the above
Answer: D
Diff: 2
Topic: 12.3 Strategic Management of Operating Exposure
Skill: Conceptual

4) Purely domestic firms will be at a disadvantage to MNEs in the event of market disequilibria
because:
A) domestic firms lack comparative data from its own sources.
B) international firms are already so large.
C) all of the domestic firm's raw materials are imported.
D) None of the above; domestic firms are not at a disadvantage.
Answer: A
Diff: 2
Topic: 12.3 Strategic Management of Operating Exposure
Skill: Conceptual

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5) Which of the following is probably NOT an advantage of foreign exchange risk management?
A) the reduction of the variability of cash flows due to domestic business cycles
B) increased availability of capital
C) reduced cost of capital
D) All of the above are potential advantages of foreign exchange risk management.
Answer: D
Diff: 2
Topic: 12.3 Strategic Management of Operating Exposure
Skill: Recognition

6) Which of the following is NOT an example of a form of political risk that might be avoided or
reduced by foreign exchange risk management?
A) expropriation of assets
B) destruction of raw materials through natural disaster
C) war
D) unfavorable legal changes
Answer: B
Diff: 2
Topic: 12.3 Strategic Management of Operating Exposure
Skill: Recognition

True/False

1) Management must be able to predict disequilibria in international markets to take advantage of

diversification strategies.
Answer: FALSE
Comment: Management must only be able to recognize disequilibria in international markets to
take advantage of diversification strategies.
Diff: 1
Topic: 12.3 Strategic Management of Operating Exposure
Skill: Conceptual

2) If a firm diversifies its financing sources, it will be pre-positioned to take advantage of

temporary deviations from the International Fisher Effect.
Answer: TRUE
Diff: 2
Topic: 12.3 Strategic Management of Operating Exposure
Skill: Conceptual

3) Diversifying the financing base means diversifying sales, location of production facilities, and
raw material sources.
Answer: FALSE
Diff: 1
Topic: 12.3 Strategic Management of Operating Exposure
Skill: Recognition

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4) The variability of a firm's operating cash flows is probably reduced by international
diversification of its production, sourcing, and sales because exchange rate changes under
disequilibrium conditions are likely to increase the firm''s competitiveness in some markets while
reducing it in others.
Answer: TRUE
Diff: 2
Topic: 12.3 Strategic Management of Operating Exposure
Skill: Conceptual

Essay

1) Diversification is possibly the best technique for reducing the problems associated with
international transactions. Provide one example each of international financial diversification and
international operational diversification and explain how the action reduces risk.
Answer: An MNE well known in the financial markets could borrow money in a country in
which the firm receives foreign currency. The MNE could then use the receivables to repay the
loan in the foreign currency and avoid uncertainties in exchange rates.
An MNE could establish production facilities in several countries. This could be beneficial in at
least two ways. First, such diversification reduces the probability of unfavorable changes in
exchange rates for one country from significantly reducing the firm's profitability. Second, an
MNE with facilities in several countries is well positioned by using internal sources to recognize
when a disequilibria in the market arises.
Diff: 3
Topic: 12.3 Strategic Management of Operating Exposure
Skill: Conceptual

12.4 Proactive Management of Operating Exposure

Multiple Choice

1) Which of the following is NOT identified by your authors as a proactive management

technique to reduce exposure to foreign exchange risk?
A) matching currency cash flows
B) cross-currency swaps
C) remaining a purely domestic firm
D) parallel loans
Answer: C
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

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2) Which one of the following management techniques is likely to best offset the risk of long-run
exposure to receivables denominated in a particular foreign currency?
A) Borrow money in the foreign currency in question.
B) Lend money in the foreign currency in question.
C) Increase sales to that country.
D) Increase sales in this country.
Answer: A
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Conceptual

3) Which one of the following management techniques is likely to best offset the risk of long-run
exposure to payables denominated in a particular foreign currency?
A) Borrow money in the foreign currency in question.
B) Lend money in the foreign currency in question.
C) Rely on the Federal Reserve Board to enact monetary policy favorable to your exposure risk.
D) none of the above
Answer: B
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Conceptual

4) The particular strategy of trying to offset stable inflows of cash from one country with
outflows of cash in the same currency is known as:
A) hedging.
B) diversification.
C) matching.
D) balancing.
Answer: C
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

5) Which of the following is NOT an acceptable hedging technique to reduce risk caused by a
relatively predictable long-term foreign currency inflow of Japanese yen?
A) Import raw materials from Japan denominated in yen to substitute for domestic suppliers.
B) Pay suppliers from other countries in yen.
C) Import raw materials from Japan denominated in dollars.
D) Acquire debt denominated in yen.
Answer: C
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

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6) An MNE has a contract for a relatively predictable long-term inflow of Japanese yen that the
firm chooses to hedge by seeking out potential suppliers in Japan. This hedging strategy is
referred to as:
A) a natural hedge.
B) currency-switching.
C) matching.
D) diversification.
Answer: A
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

7) An MNE has a contract for a relatively predictable long-term inflow of Japanese yen that the
firm chooses to hedge by paying for imports from Canada in Japanese yen. This hedging strategy
is known as:
A) a natural hedge.
B) currency-switching.
C) matching.
D) diversification.
Answer: B
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

8) A U.S. timber products firm has a long-term contract to import unprocessed logs from
Canada. To avoid occasional and unpredictable changes in the exchange rate between the U.S.
dollar and the Canadian dollar, the firms agree to split between the two firms the impact of any
exchange rate movement. This type of agreement is referred to as:
A) risk-sharing.
B) currency-switching.
C) matching.
D) a natural hedge.
Answer: A
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Conceptual

9) A ________ occurs when two business firms in separate countries arrange to borrow each
other's currency for a specified period of time.
A) natural hedge loan
B) forward loan
C) currency switch loan
D) back-to-back loan
Answer: D
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

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10) A Canadian firm with a U.S. subsidiary and a U.S. firm with a Canadian subsidiary agree to
a parallel loan agreement. In such an agreement, the Canadian firm is making a/an ________
loan to the ________ subsidiary while effectively financing the ________ subsidiary.
A) indirect; U.S.; Canadian
B) indirect; Canadian; U.S.
C) direct; U.S.; Canadian
D) direct; Canadian; U.S.
Answer: C
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Conceptual

11) Which of the following is NOT an important impediment to widespread use of parallel
loans?
A) difficulty in finding an appropriate counterparty
B) the risk that one of the parties will fail to return the borrowed funds when agreed
C) the process does not avoid exchange rate risk
D) All of the above are significant impediments.
Answer: C
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Conceptual

12) A ________ resembles a back-to-back loan except that it does not appear on a firm's balance
sheet.
A) forward loan
B) currency hedge
C) counterparty
D) currency swap
Answer: D
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Conceptual

13) A ________ is the term used to describe a foreign currency agreement between two parties to
exchange a given amount of one currency for another, and after a period of time, to give back the
original amounts.
A) matched flow
B) currency swap
C) back-to-back loan
D) none of the above
Answer: B
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

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14) A British firm and a U.S. Corporation each wish to enter into a currency swap hedging
agreement. The British firm is receiving U.S. dollars from sales in the U.S. but wants pounds.
The U.S. firm is receiving pounds from sales in Britain but wants dollars. Which of the following
choices would best satisfy the desires of the firms?
A) The British firm pays dollars to a swap dealer and receives pounds from the dealer. The U.S.
firm pays pounds to the swap dealer and receives dollars.
B) The U.S. firm pays dollars to a swap dealer and receives pounds from the dealer. The British
firm pays pounds to the swap dealer and receives dollars.
C) The British firm pays pounds to a swap dealer and receives pounds from the dealer. The U.S.
firm pays dollars to the swap dealer and receives dollars.
D) The British firm pays dollars to a swap dealer and receives dollars from the dealer. The U.S.
firm pays pounds to the swap dealer and receives pounds.
Answer: A
Diff: 3
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Conceptual

15) Reinvoicing centers provide the following benefit(s):

A) aid in the management of foreign exchange exposure.
B) effectively guarantee the exchange rate for future orders.
C) help manage intra-subsidiary cash flows.
D) all of the above
Answer: D
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

16) NorthRim Inc. (NRI), imports extreme condition outdoor wear and equipment from the
Allofit Territories Company (ATC) located in Canada. With the steady decline of the U.S dollar
against the Canadian dollar NRI is finding a continued relationship with ATC to be an
increasingly difficult proposition. In response to NRI's request, ATC has proposed the following
risk-sharing arrangement. First, set the current spot rate as the base rate. As long as spot rates
stay within 5% (up or down) NRI will pay at the base rate. Any rate outside of the 5% range,
ATC will share equally with NRI the difference between the spot rate and the base rate. If the
current spot rate is C$1.20/$, what are the upper and lower limits for trading to take place at
C$1.20?
A) C$1.205/$ - C$1.195/$
B) C$1.15/$ - C$1.25/$
C) C$1.14/$ - C$1.26/$
D) none of the above
Answer: C
Diff: 3
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Analytical

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17) NorthRim Inc. (NRI), imports extreme condition outdoor wear and equipment from The
Allofit Territories Company (ATC) located in Canada. With the steady decline of the U.S dollar
against the Canadian dollar NRI is finding a continued relationship with ATC to be an
increasingly difficult proposition. In response to NRI's request, ATC has proposed the following
risk-sharing arrangement. First, set the current spot rate as the base rate. As long as spot rates
stay within 5% (up or down) NRI will pay at the base rate. Any rate outside of the 5% range,
ATC will share equally with NRI the difference between the spot rate and the base rate. If NRI
has a payable of C$100,000 due today and the current spot rate is C$1.17/$, how much does
LBC owe in U.S. dollars?
A) $83,333
B) $85,470
C) $85,837
D) $117,000
Answer: A
Diff: 3
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Analytical

18) Costs associated with the purchase of sizeable put options positions include each of the
following EXCEPT:
A) the purchase price of the options.
B) the opportunity cost of buying the options rather than diversifying operations to reduce risk.
C) executive salaries of having corporate offices in more than one country.
D) none of the above
Answer: C
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

True/False

1) Currency swaps are exclusively for periods of time under one year.
Answer: FALSE
Comment: Currency swaps may have maturities of 10 years or more.
Diff: 1
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

2) Most swap dealers arrange swaps so that each firm that is a party to the transaction does not
know who the counterparty is.
Answer: TRUE
Diff: 1
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

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3) Most swap dealers arrange swaps so that each firm that is a party to the transaction knows
who the counterparty is.
Answer: FALSE
Comment: The counterparty is typically unknown.
Diff: 1
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

4) Swap agreements are treated as off-balance sheet transactions via U.S. accounting methods.
Answer: TRUE
Diff: 1
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

5) Swap agreements are treated as line items on the balance sheet via U.S. accounting methods.
Answer: FALSE
Comment: A currency swap is treated as a foreign exchange transaction.
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

6) After being introduced in the 1980s, currency swaps have remained a relatively insignificant
financial derivative instrument.
Answer: FALSE
Comment: Currency swaps have grown to be one of the largest financial derivative markets in
the world.
Diff: 1
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

7) After being introduced in the 1980s, currency swaps have gained increasing importance as
financial derivative instruments.
Answer: TRUE
Diff: 1
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

8) The empirical evidence strongly supports the proposition that contractual hedges can
effectively eliminate operating exposure.
Answer: FALSE
Comment: A significant question remains as to the effectiveness of contractual hedges.
Diff: 2
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Recognition

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Essay

1) A British firm has a subsidiary in the U.S., and a U.S. firm, known to the British firm, has a
subsidiary in Britain. Define and then provide an example for each of the following management
techniques for reducing the firm's operating cash flows. The following are techniques to
consider:
a) matching currency cash flows
b) risk-sharing agreements
c) back-to-back or parallel loans
Answer:
a) Matching currency cash flows requires that the British firm with dollar receivables must
establish an equivalent dollar payable. They could do this by borrowing dollars and repaying the
loan with the proceeds from the receivables account. Or they could move all or part of their
operations to the U.S. so that both receivables and payables would be in U.S. dollars.
b) Risk-sharing agreements are contractual clauses whereby both parties agree to an acceptable
range of exchange rates at the time the international sale is made. A spot rate at time of exchange
outside of the agreed upon range results in an adjustment made to the actual exchange rate that
shares the difference between the spot rate and the acceptable range of exchange rates.
c) Back-to-back loans provide for parent-subsidiary cross border financing without incurring
direct currency exposure. For example, using our British and U.S. firms, the British firm could
lend pounds to the U.S. subsidiary in Britain at the same time that the U.S. firm lends an
equivalent amount of dollars to the British subsidiary in the U.S. Later, the loans would be
simultaneously repaid.
Diff: 3
Topic: 12.4 Proactive Management of Operating Exposure
Skill: Analytical

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