Multiple choice question

1. In a small, completely open economy,

(a) PPP holds relative to the surrounding countries.

(b) A 10 percent devaluation of the host currency will be offset by a 10 percent rise in the host country prices.

(c) The value of a foreign subsidiary, in units of the foreign parent's home currency, is unaffected by exchange rate changes.

(d) The real value of a foreign subsidiary to an investor from the host country is unaffected by exchange rate changes.

(e) In the absence of contracts with a value fixed in the host currency, the real value of a foreign subsidiary to an investor from the parent's home country is unaffected by exchange rate changes.

(f) In the absence of contracts with a value that is fixed in foreign currency, the real value of a foreign subsidiary to an investor from the host country is unaffected by exchange rate changes.

(g) There is little or no advantage to having one's own currency: exchange rate policy has virtually no effects.

2. In a completely closed economy,

(a) PPP holds relative to the surrounding countries.

(b) A 10 percent devaluation of the host currency will be offset by a 10 percent rise in the host country prices.

(c) The value of a foreign subsidiary, in units of the foreign parent's home currency, is unaffected by exchange rate changes.

(d) The real value of a foreign subsidiary to an investor from the host country is unaffected by exchange rate changes.

(e) In the absence of contracts with a value fixed in host currency, the real value of a foreign subsidiary to an investor from the parent's home country is unaffected by exchange rate changes.

(f) In the absence of contracts with a value that is fixed in foreign currency, the real value of a foreign subsidiary to an investor from the host country is unaffected by exchange rate changes.

(g) There is little or no advantage to having one's own currency: exchange rate policy has virtually no effects.

3. In an economy that is neither perfectly open nor completely closed,

(a) Consider a company that produces and sells in this economy. Apart from contractual exposure effects, its value in terms of its own (local) currency is positively exposed to the value of other currencies.

(b) The value of an importing firm located in this economy could either go up or go down when the local currency devalues: the effect depends on such factors as the elasticity of local demand and foreign supply.

(c) Consider a company that produces and sells in this economy. Apart from contractual exposure effects, its value in terms of a foreign currency is positively exposed to the value of its currency expressed in terms of other currencies.

4. Suppose that the value of the firm, expressed in terms of the owner's currency, is a linear function of the exchange rate up to random noise.

(a) The firm's exposure is the constant at,T in VT(i) = at,T + bt,T ST(i) + et,T(i).

(b) The exposure is hedged by buying forward bt,T units of foreign currency.

(c) Hedging means that all risk is eliminated.

5. Suppose that the value of the firm, expressed in terms of the owner's currency, is a nonlinear function of the exchange rate up to random noise. Suppose that you fit a linear regression through this relationship, and you hedge with a forward sale with size equal to the regression coefficient.

(a) All risk will be eliminated.

(b) There is remaining risk, but it is entirely independent of the realized value of the exchange rate.

(c) There is remaining risk, but it is uncorrelated to the realized value of the exchange rate.

(d) There is no way to further reduce the variance of the firm's hedged value.

(e) There is no way to further reduce the variance of the firm's hedged value if only exchange rate hedges can be used.

(f) There is no way to further reduce the variance of the firm's hedged value if only linear exchange rate hedges can be used.