Foreign Currency Risk

FOREIGN CURRENCY RISK
Q1. Jack is a UK based car exporter who exports luxury cars and has a competitor in Germany; he has recently seen a change in foreign currency that pound (£) of UK has strengthened against euro (€) of Germany. What is the type of risk does Jack face in his business? (MCQ)Credit RiskTranslation Risk Economic Risk Transaction Risk(2 marks)
Q2. Yarn Co is multinational business & wants its foreign subsidiary financial statements. They are making exchange losses when the accounting results of its foreign subsidiary are translated into the home currency. Which type of currency risk does Yarn Co face? (MCQ)Netting off RiskTranslation Risk Economic Risk Hedging Risk(2 marks)

Q3. Saito Co, a USA based fish exporter has competition with Sakkara Co based in Bangladesh. He believes he faces an economic risk in the business. What type of impact does it have on Saito Co? (MCQ)Direct ImpactIndirect ImpactPolitical ImpactEconomic Impact(2 marks)
Q4. The current spot rate of UK (£) to USA ($) is £3:$1.5. The interest rates per annum are UK 5% & USA 9%. What will be the two-month forward rate (to the nearest two decimal places)? (FIB)4013204318000£ :$1(2 marks)
Q5. The current spot rate of UK (£) is £3. The inflation rate per annum of UK is 3% & the expected future six-month spot rate is £3.06. Calculate the foreign annual inflation rate? (FIB)501656223000%(2 marks)
Q6. Which of the following statements relates to International Fisher Effect? (MCQ)The exchange rates of countries depending on inflation ratesThe exchange rates of countries depending on interest ratesPrices are same to different customers in an economyNominal interest rate differentials between countries provide an unbiased predictor of future changes in spot exchange rates.(2 marks)
Q7. Which of the following differences will result in an Expectation Theory? (MRQ)The difference in Inflation RatesDifference between Spot & Forward RatesThe difference of Interest RatesDifference between Spot & Future Rates(2 marks)
Q8. Select the appropriate theory with the following statements. (P&D)Depreciation of forwarding rates will be due to high-interest rates Differences in nominal rates due inflation rates A commodity is priced same in every country The forward rate is a fair predictor of the spot rate in the future
EXPECTATION THEORY PURCHASING POWER PARITY THEORY INTERNATIONAL FISHER EFFECT INTEREST RATE PARITY THEORY(2 marks)
Q9. Patio Co. operates in the USA. They will be receiving a payment of £2,500 from customers in four months’ time. Calculate Patio Co.’s receipts in four months’ time? Use the following rates. (MCQ)Spot Rate £1.4/$ – £1.6/$4 Month Forward Rate £1.8/$ – £2.0/$$1,786$1,563$1,389$1,250(2 marks)
Q10. Fray Co is a USA based company ; imports Robots from China. The usual credit period is three months. Fray Co has to pay ¥60,000. Calculate the loss/gain of the payment on forwarding contract? (MCQ)Spot Rate ¥1.321/$ – ¥1.521/$3 Month Forward Rate ¥1.654/$ – ¥1.854/$$7,085 (Loss)$9,144 (Loss)$9,144 (Gain)$7,085 (Gain)(2 marks)
Q11. PXG Co, a UK based company has made $3,600 sale to its USA customer on credit. The current £/$ exchange rate is £6.4/$12.8. It is expected that UK £ will strengthen by 15%, by the time USA customer pays. Calculate the receipts in £? (MCQ)£244.57£281.25£489.13£562.5(2 marks)
Q12. The dollar is quoted at a $0.067 premium for the forward rate. The current exchange rate is $/¥ 1.0005 +/- 0.0045. What will a $4,900 payment convert at forwarding rate? (MCQ)¥4,876¥4,920¥5,224¥5,274(2 marks)
Q13. A UK based company Bib Co will receive a foreign payment of $2,000 in four months’ time. The spot rate is $1.1/£ – $1.4/£. Calculate the income in four months’ time using money market hedging? (MCQ) Borrow DepositDollar ($) 4% 5%Pounds (£) 3% 2%£1,414.4£1,419.4£1,800£1,807(2 marks)
This information is used for Q14, Q15 ; Q16.A USA based company has to make a payment of £95,000 in nine months’ time. The spot rate is £2.2/$ – £2.5/$. Following details are:Borrow DepositDollar ($) 7% 5%Pounds (£) 5% 3%
Q14. Calculate the foreign payment using money market hedging? (MCQ) $37,164$42,232$43,816$44,449(2 marks)
Q15. Calculate the foreign payment if the nine-month forward rate is £2.37/$ – £2.71/$? (FIB)3511551206500$ (2 marks)
Q16. Calculate the gain/loss for the company for not leading the payment? (MCQ)$4,365 (Gain)$4,365 (Loss)$3,816 (Loss)$3,816 (Gain)(2 marks)
Q17. Following statements relate to Forwarding contracts. (HA)An immediate binding contract TRUE FALSEThe forward rate is variable in nature TRUE FALSEThe timing of the contract is unknown TRUE FALSE(2 marks)
Q18. A company wants to reduce its transaction risks when conducting business with foreign receivables/payables. Following statements are said by the directors during this years’ AGM. Select the appropriate statements to reduce the risk. (MRQ) “The company should hold back its payments for few months”, this technique is Leading”The company should continue as normal””I have some friends offshore who work in a bank, I may able to arrange a foreign account for the company” said by a director”The company should deal in the foreign currency only” (2 marks)
Q19. Juab Co is a manufacturing company ; has a foreign supplier who supplies raw materials. Recently the supplier has now become a customer as well, who purchases Juab Co.’s finished products and sells in his respective country. Which technique of reducing risk is applicable for Juab Co? (MCQ) Money market contractLeading & LaggingForward market hedgingMatching & Netting(2 marks)
Q20. Which of the following statements are true in relation to futures? (MRQ)Currency futures are standard contractsA high premium is paid initiallyFutures are available in all currencies offered by the bankFuture contracts are binding (2 marks)
Q21. A company wants to hedge itself from any currency risk. They have decided to hedge themselves using currency futures. They have to make a payment in May of $36,000. The futures have a contract size of $15,000. Which of the following futures will they select? (MCQ)Buy three futures on MarchSell two futures of MarchBuy two futures of JuneBuy three futures of September(2 marks)
Q22. Select the appropriate option in relation to futures. (HA) Transaction cost is lowest ADVANTAGE DISADVANTAGEContracts are limited to some currencies ADVANTAGE DISADVANTAGEThe exact date does not have to be known ADVANTAGE DISADVANTAGE(2 marks)
Q23. Picots Co is UK based company which has a lot of foreign customers. It will be receiving a payment from USA based customer of $500,000 in five months. The company has been advised to use derivatives to hedge themselves against any currency risk. If they opt for currency options which of the following are correct? (MCQ)Buying a USA $ call option in the UKBuying a USA $ put option in the UKBuying a UK £ call option in the USABuying a UK £ put option in the USA (2 marks)
Q24. Which of the following statements relate to currency options? (MRQ)In future the market becomes favorable and the company will face a loss because it is bound to the contractThey are negotiated Cannot be traded in all currenciesEasily arranged & Flexible (2 marks)
Q25. Which of the following is incorrect for swaps? (MCQ)It is negotiated between two parties having their own spot rateIt has a nominal costIt is an over the counter dealIt has multiple markets (2 marks)
Q26. Which of the following has a refundable cost? (MCQ)Currency FuturesForward ContractsCurrency OptionsCurrency Swaps(2 marks)
FOREIGN CURRENCY RISK (ANSWERS)
Q1. CEconomic risk is the variation in the value of the business due to unexpected changes in exchange rates. This is an indirect impact on Jacks business.
Q2. BThey are making exchange losses when the accounting results of its foreign subsidiary are translated into the home currency. This is an indication of Translation Risk.
Q3. AIt is a direct impact on Saito Co as the USA being home currency strengthens then foreign competitors Sakkara Co in Bangladesh is able to gain sales at your expense because your fish have become more expensive in the eyes of customers both abroad and at home.
Q4. £3.02Interest rate parity theory = 3 × 1+(9% × 212)1+(5% ×212) = £3.02
Q5. 7%Purchasing power parity theory = 3 × 1+(x% × 612)1+(3% ×612) = £3.06X% = 7%
Q6. DThe exchange rates of countries depending on inflation rates (Purchasing Power Parity Theory)The exchange rates of countries depending on interest rates (Interest Rate Parity Theory)Prices are same to different customers in an economy. The law of one price. (Purchasing Power Parity Theory)Nominal interest rate differentials between countries provide an unbiased predictor of future changes in spot exchange rates. (International Fisher Effect)
Q7. When these two will become equal, Expectation Theory arises. Difference between Spot & Forward RatesDifference between Spot & Future Rates
Q8.Depreciation of forwarding rates will be due to high-interest rates
INTEREST RATE PARITY THEORYDifferences in nominal rates due to inflation rates
INTERNATIONAL FISHER EFFECTA commodity is priced same in every country
PURCHASING POWER PARITY THEORYThe forward rate is a fair predictor of the spot rate in the future
EXPECTATION THEORY
Q9. DReceipts = £2,500 ÷ 2.0 = $1,250Q10.Payment (Forward) = ¥60,000 ÷ 1.654 = $36,276Payment (Spot) = ¥60,000 ÷ 1.321 = $45,420Gain = $9,144Q11. AFuture Rate = $12.8 × 115% = $14.72Receipts = £3,600 ÷ 14.72 = $244.57
Q12. DThe Spot rate = $0.996/¥ – $1.005/¥ -/+ 0.0045The dollar is at a premium so subtract it as if dollar strengthens then yen will weaken in the forwards market. The new Spot rate = $0.929/¥ – $0.938/¥ – 0.067Payment = $4,900 ÷ 0.929 = ¥5,274
Q13. BBorrow Foreign Currency = $2,000 ÷ [1 + (4% × 4/12)] = $1,974Convert Foreign to Local = $1,974 ÷ 1.4 = £1,410Deposit (Interest) = (1,410 × 2% × 4/12) = £9.4Total Receipts = £1,410 + £9.4 = £1,419.4
Q14. DDeposit Foreign Currency = £95,000 ÷ [1 + (3% × 9/12)] = £92,910Convert Foreign to Local = £92,910 ÷ 2.2 = $42,232Deposit (Interest) = ($42,232 × 7% × 9/12) = $2,217Total Payments = $42,232 + $2,217 = $44,449
Q15. $40,084Payments = £95,000 ÷ 2.37 = $40,084Q16.
BQ17. An immediate binding contract TRUE The forward rate is variable in nature FALSEThe timing of the contract is unknown FALSE
Q18.”The company should hold back its payments for few months”, this technique is Lagging (Incorrect)”The company should continue as normal” This refers the company should take no action (Correct)”I have some friends offshore who work in a bank, I may able to arrange a foreign account for the company” said by a director. This statement indicates opening a foreign bank account. (Correct)”The company should deal in the foreign currency only” The company could deal in home currency rather in foreign currency (Incorrect)
Q19. DThis technique attempts to match the same foreign currency receipt & payments due at the same time. The netting of the intra debit & credit balances saving transaction cost & reducing risk.
Q20.Currency futures are standard contracts, fixed limits specified (True)A high premium is paid initially, this is applicable in options (False)Futures are available in all currencies offered by the bank, Only in few currencies (False)Future contracts are binding, they have to be closed (True)
Q21. CThe Futures can be bought or sold only four times a year which are March, June, September & December. Future contracts can be signed relating to a month after the date of receipt. They will buy two futures each of $15,000 and the remaining $6,000 can be hedged using other techniques. (E.g. forward contracts)
Q22. Transaction cost is lowest ADVANTAGE Contracts are limited to some currencies DISADVANTAGEThe exact date does not have to be known ADVANTAGE
Q23. BPicots Co will want to sell the USA $ when they receive the payment which is why they will use USA $ put (sell) option bought in the UK.
Q24. In future the market becomes favorable and the company will face a loss because it is bound to the contract, this statement relates to future contracts They are negotiated, this statement relates to options (Correct) Cannot be traded in all currencies, it is a disadvantage hence this statement relates to options (Correct)Easily arranged & Flexible, this statement relates to swaps
Q25. DIt has no markets; it is a tailor-made an agreement between two parties.Q26. ACurrency Futures, An initial margin cost which is refundableForward Contracts, has a transaction costCurrency Options, A non-refundable premium costCurrency Swaps, No initial cost