"Measuring Exposure to Exchange Rate Fluctuations, "Managing Transaction Exposure, "Managing Economic Exposure and Translation Exposure."

Instructions:

1. Factors That Affect a Firm's Transaction Exposure
   • What factors affect a firm's degree of transaction exposure in a particular currency? For each factor, explain the desirable characteristics that would reduce transaction exposure.
2. Hedging Translation Exposure
   • Explain how a firm can hedge its translation exposure.
3. Forecasting with IFE and Hedging
   • Assume that Calumet Co. will receive 10 million pesos in 15 months. It does not have a relationship with a bank at this time, and therefore cannot obtain a forward contract to hedge its receivables at this time. However, in three months, it will be able to obtain a one-year (12-month) forward contract to hedge its receivables. Today the three-month U.S. interest rate is 2 percent (not annualized), the 12-month U.S. interest rate is 8 percent, the three-month Mexican peso interest rate is 5 percent (not annualized), and the 12-month peso interest rate is 20 percent. Assume that interest rate parity exists. Assume the international Fisher effect exists. Assume that the existing interest rates are expected to remain constant over time. The spot rate of the Mexican peso today is $.10.
     • Based on this information, estimate the amount of dollars that Calumet Co. will receive in 15 months.
4. Long-term Hedging With Forward Contracts
   • Tampa Co. will build airplanes and export them to Mexico for delivery in 3 years. The total payment to be received in 3 years for these exports is 900 million pesos. Today the peso's spot rate is $.10. The annual U.S. interest rate is 4 percent, regardless of the debt maturity. The annual peso interest rate is 9 percent regardless of the debt maturity. Tampa plans to hedge its exposure with a forward contract that it will arrange today. Assume that interest rate parity exists.
     • Determine the dollar amount that Tampa will receive in 3 years.
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