Question

1. You are the CFO of a Swiss firm purchasing a German firm for Euros. You have already signed a contract and will make payment and receive control of the firm in one month. You have incurred:
   1. Contingent exposure
   2. Operating exposure
   3. Translation exposure
   4. Transaction exposure
2. You are worried that the government of Anarchistan might expropriate the widget factory you are building there. Which one of the following actions would not be useful to alleviate this worry?
   1. Take out fronting loans
   2. Finance the project largely with locally raised debt
   3. Only use your facility there for final assembly, and keep the machinery and expertise needed for the difficult and interesting parts of widget making back in the US
   4. Raise capital for this project from several major international bank

Answer 1

Answer-

The correct Option is d. Trasaction exposure.
Transaction exposure occurs the moment a company enters into a transaction which involves foreign currency and a committment or agreement is signed to make or receive payment in currency other than its domestic currency.

The other Options are incorrect.

The Option a is Contingent exposure that refers to the amount of potential liability that is recorded by a lending bank or institution with respect to a transaction that is done by recipient of the loan.

The Option b is Operating exposure which refers to the present value of a firm resulting from changes in operating cash flows in future that happens due to unexpected change in exchange rates.

The Option c is Translation exposure that occurs on the balance sheet consolidation date and happens at the end of a given financial period.

Answer-

The Correct Option is b. Finance the project largely with locally raised debt

The government of Anarchistan intention to expropriate the widget factory will not alleviate or lessen the worry by Finance the project largely with locally raised debt. Finance the project largely with locally raised debt will improve the risk as the expropriation will not be dealt with international laws as the local debt from institutions will be easily dealt with local laws and local courts.

The other option will alleviate or lessen the worry as

The Option a is Fronting loan is debt that is provided through a third-party intermediary to a parent company that allocates the funds to a subsidiary unit by multinational companies which will not incur loss to the company.

The Option c is the final assembly that is done locally wheras the machinery and expertise needed for the difficult and interesting parts of widget making back in the US will alleviate the worry as the company can immediately shift its assembly unit.

The Option d by raising capital for this project from several major international bank will help to file and fight the case in international court incase of expropriation of widget company.