【正文】 CHAPTER 8 MANAGEMENT OF TRANSACTION EXPOSURESUGGESTED ANSWERS AND SOLUTIONS TO ENDOFCHAPTER QUESTIONS AND PROBLEMSQUESTIONS 1. How would you define transaction exposure? How is it different from economic exposure?Answer: Transaction exposure is the sensitivity of realized domestic currency values of the firm’s contractual cash flows denominated in foreign currencies to unexpected changes in exchange rates. Unlike economic exposure, transaction exposure is welldefined and shortterm.2. Discuss and pare hedging transaction exposure using the forward contract vs. money market instruments. When do the alternative hedging approaches produce the same result?Answer: Hedging transaction exposure by a forward contract is achieved by selling or buying foreign currency receivables or payables forward. On the other hand, money market hedge is achieved by borrowing or lending the present value of foreign currency receivables or payables, thereby creating offsetting foreign currency positions. If the interest rate parity is holding, the two hedging methods are equivalent.3. Discuss and pare the costs of hedging via the forward contract and the options contract.Answer: There is no upfront cost of hedging by forward contracts. In the case of options hedging, however, hedgers should pay the premiums for the contracts upfront. The cost of forward hedging, however, may be realized ex post when the hedger regrets his/her hedging decision.4. What are the advantages of a currency options contract as a hedging tool pared with the forward contract?Answer: The main advantage of using options contracts for hedging is that the hedger can decide whether to exercise options upon observing the realized future exchange rate. Options thus provide a hedge against ex post regret that forward hedger might have to suffer. Hedgers can only eliminate the downside risk while retaining the upside potential.5. Suppose your pany has purchased a put option on the German mark to manage exchange exposure associated with an account receivable denominated in that currency. In this case, your pany can be said to have an ‘insurance’ policy on its receivable. Explain in what sense this is so.Answer: Your pany in this case knows in advance that it will receive a certain minimum dollar amount no matter what might happen to the $/€ exchange rate. Furthermore, if the German mark appreciates, your pany will benefit from the rising euro.6. Recent surveys of corporate exchange risk management practices indicate that many . firms simply do not hedge. How would you explain this result?Answer: There can be many possible reasons for this. First, many firms may feel that they are not really exposed to exchange risk due to product diversification, diversified markets for their products, etc. Second, firms may be using selfinsurance against exchange risk. Third, firms may feel that shareholders can diversify exchange risk themselves, rendering corporate risk management unnecessary. 7. Should a firm hedge? Why or why not?Answer: In a perfect capital market, firms may not need to hedge exchange risk. But firms can add to their value by hedging if markets are imperfect. First, if management knows about the firm’s exposure better than shareholders, the firm, not its shareholders, should hedge. Second, firms may be able to hedge at a lower cost. Third, if default costs are significant, corporate hedging can be justifiable because it reduces the probability of default. Fourth, if the firm faces progressive taxes, it can reduce tax obligations by hedging which stabilizes corporate earnings.8. Using an example, discuss the possible effect of hedging on a firm’s tax obligations.Answer: One can use an example similar to the one presented in the chapter. 9. Explain contingent exposure and discuss the advantages of using currency options to manage this type of currency exposure.Answer: Companies may encounter a situation where they may or may not face currency exposure. In this situation, panies need options, not obligations, to buy or sell a given amount of foreign exchange they may or may not receive or have to pay. If panies either hedge using forward contracts or do not hedge at all, they may face definite currency exposure.10. Explain crosshedging and discuss the factors determining its effectiveness.Answer: Crosshedging involves hedging a position in one asset by taking a position in another asset. The effectiveness of crosshedging would depend on the strength and stability of the relationship between the two assets.PROBLEMS1. Cray Research sold a super puter to the Max Planck Institute in Germany on credit and invoiced €10 million payable in six months. Currently, the sixmonth forward exchange rate is $€ and the foreign exchange advisor for Cray Research predicts that the spot rate is likely to be $€ in six months.(a) What is the expected gain/loss from the forward hedging?(b) If you were the financial manager of Cray Research, would you remend hedging this euro receivable? Why or why not?(c) Suppose the foreign exchange advisor predicts that the future spot rate will be the same as the forward exchange rate quoted today. Would you remend hedging in this case? Why or why not?Solution: (a) Expected gain($) = 10,000,000( – )= 10,000,000(.05)= $500,000.(b) I would remend hedging because Cray Research can increase the expected dollar receipt by $500,000 and also eliminate the exchange risk.(c) Since I eliminate risk without sacrificing dollar receipt, I still would remend hedging.2. IBM purchased puter chips from NEC, a Japanese electronics concern, and was billed 165。250 million payable in three months. Currently, the spot exchange rate is 165。105/$ and the threemonth forward rate is 165。100/$. The threemonth money market interest rate is 8 percent per annum in the . and 7 percent per annum in Japan. The management of IBM decide