Question

)ABC stock is seiortslae, Ho $45 is priced at $.30. Risk-free assets are currently returning. 18 percent per month What is the price of a 6-month put on this stock with a strike price of $45? A) S1.99 B) $1.29 C) $1.82 D) $1.70 E) S1.49 18) Which one of the following statements is correct? A) Accounting translation gains and losses are recorded in the equity section of the balance sheet. B) A firm can record a profit on its income statement from a foreign subsidiary even when that subsidiary has no profit thanks to exchange rate risk. C) There is no known method of reducing long-run exchange rate risk. D) Unexpected changes in economic conditions are classified as short-run exposure to exchange rate risk he use of forward rates increases the short-run exposure to exchange rate risk. A-4

Answer 1

A) Wrong, Translation gains/losses can affect the assets and liabilities also

B) True. Even tough the subsidiary doesn't have actual profit, exchange rate fluctuations might cause a profit after converting to another currency.

For example: suppose Company A in India(subsidiary of a US firm)  is importing raw material from US and selling finished products in India

For simplicity, let us consider exchange rate is 1$=Rs. 70

Let following be the income statement of company A

Import cost: $5 = Rs 350

Extra cost for making = Rs 150

Total = Rs 500

Sales revenue = Rs 500

There is no profit.

Now, supposes, by the time profits and translated to US firm, exchange rate falls to $1= Rs 50

Import cost = $5

Extra cost of making =$3

Sales revenue = $10

There is a profit of $2

C) Wrong: Long run risk can be hedged with long term forward contracts or taking/giving loans in the foreign currency

D) Wrong: Short run exchange risk is the risk that exchange rate might be unfavorable in short term. Changes in economic conditions will cause long term risk

E) Wrong: Using forward will help to hedge the exchange rate risk and therefore reduce risk