Question 1: (10 marks)Distinguish between the following types of foreign exchange exposure:
1. Transaction exposure
2. Economic exposure
3. Translation exposure
Given 1 example for each.
Question 2: (20 marks)
Airbus sold an A400 aircraft to Delta Airlines, a U.S. company, and billed $30 million payable in six months. Airbus is concerned about the euro proceeds from international sales and
would like to control exchange risk. The current spot exchange rate is $1.05/€ and the sixmonth forward exchange rate is $1.10/€. Airbus can buy a six-month put option on U.S.
dollars with a strike price of €0.95/$ for a premium of €0.02 per U.S. dollar. Currently, sixmonth interest rate is 2.5 percent in the euro zone and 3.0 percent in the United States.
a. Should a firm hedge? Why or why not? (5 marks)
b. Compute the guaranteed euro proceeds from the American sale if Airbus decides to
hedge using a forward contract. (2 marks)
c. If Airbus decides to hedge using money market instruments, what action does Airbus
need to take? What would be the guaranteed euro proceeds from the American sale in
this case? (5 marks)
d. If Airbus decides to hedge using put options on U.S. dollars, what would be the
“expected” euro proceeds from the American sale? Assume that Airbus regards the
current forward exchange rate as an unbiased predictor of the future spot exchange
rate. (5 marks)
e. At what future spot exchange do you think Airbus will be indifferent between the
option and money market hedge? (3 marks)
Question 3: (20 marks)
A U.S. firm holds an asset in France and faces the following scenario:
Probability
Spot rate
P*
P
State 1
25%
$1.20/€
€1,500
$1,800
State 2
25%
$1.10/€
€1,400
$1,540
State 3
25%
$1.00/€
€1,300
$1,300
State 4
25%
$0.90/€
€1,200
$1,080
In the above table, P* is the euro price of the asset held by the U.S. firm and P is the dollar
price of the asset.
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a. What is the variance of the dollar price of this asset if the U.S. firm remains unhedged
against this exposure? (10 marks)
b. If the U.S. firm hedges against this exposure using the forward contract, what is the
variance of the dollar value of the hedged position? (10 marks)
Question 4: (10 marks)
What were the weaknesses of Basel II that became apparent during the global financial crisis
that began in mid-2007?
Question 5: (10 marks)
How did the credit crunch become a global financial crisis?
Question 6: (15 marks)
What is a structured investment vehicle and what effect did they have on the credit crunch?
Question 7: (15 marks)
What is a collateralized debt obligation and what effect did they have on the credit crunch?
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