Question

If the British subsidiary of a European firm has net exposed assets of £125,000, and the pound increases in value from €1.40/£ to €1.44/£, the European firm has a translation:

		loss of €5,000.
		gain of €5,000.
		gain of £5,000.
		loss of £5,000.

2)

Which of the following is probably NOT an advantage of foreign exchange risk management?

		the reduction of the variability of cash flows due to domestic business cycles
		increased availability of capital
		reduced cost of capital
		All of the above are potential advantages of foreign exchange risk management.

Answer 1

If the British subsidiary of a European firm has net exposed assets of £125,000, and the pound increases in value from €1.40/£ to €1.44/£, the European firm has to transact a €0.04/£ less for the deal. This means it will have a gain of 125,000 * 0.04/£. That means the firm will have a a translation gain of € 5,000.

So, the correct answer is B-gain of € 5,000.

There are many advantage of foreign exchange risk management with respect to the cash flow and cost of capital. The foreign market opens a wider range of market for the domestic entities and ensures more of cash flows and reduction of the variability of cash flow in just the domestic one, The increased capital availability leads to reduction of cost. So, all the above options are potential advantages of the foreign exchange risk management.

So, the correct answer is D-All of the above are potential advantages of foreign exchange risk management