Transaction risk

FM – L2 – Q98 – Foreign exchange risk and currency risk management

Accra Food and Beverage Co hedges USD189,000 net liability using forward and money market methods.

Question

Accra Food and Beverage Co has recently imported raw materials from Japan with an invoice value of US$264,000 payable in three months’ time. Due to the company’s efficient production capacity, it has finished products and exported finished products to France. Consequent to this, the French customer has been invoiced for US$75,000 payable in three months’ time. Below is the current spot and forward rates for the transactions:

USD/GHS	Spot	3 Months Forward
	0.9850-0.9870	0.9545-0.9570

Current money market rates per annum are as follows:

Currency	Borrowing	Deposits
US$ (USD)	11% – 13.2%	2.7%
GH₵ (GHS)	12.7% – 14.3%	Not provided

Required:
Demonstrate with relevant calculations how Accra Food and Beverage Co can hedge its exposure to foreign exchange risk using:
(a) The forward markets
(b) The money market

Answer

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Tags: Currency hedging, Foreign Exchange Risk, Forward Markets, Forward Rates, Interest rates, Money Markets, Net Exposure, Spot Rates, Transaction risk, USD/GHS
Level: Level 2

Topic: Foreign exchange risk and currency risk management

FM – L2 – Q91 – Foreign Exchange Risk Management

Explain how a UK company can hedge USD payment risk using a forward contract and calculate the sterling cost in 3 months.

Question

A UK company, BrightHorizon Ltd, expects to pay $750,000 to a supplier in three months’ time. The following exchange rates are available for the dollar against sterling (GBP/USD):

| Spot | 1.8570 | 1.8580 |
| 3 months forward | 1.8535 | 1.8543 |

The company is concerned about a possible increase in the value of the dollar during the next three months and would like to hedge its FX risk.

Required:
(A) Explain how the exposure to currency risk might be hedged, and the amount that BrightHorizon Ltd will have to pay in sterling in three months’ time to settle its liability.

(B) Calculate EuroTech GmbH’s income in euros from settlement of the forward contract in two months’ time.

Answer

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Tags: Currency Risk, Foreign Exchange, Forward Contract, Hedging, Transaction risk, USD/GBP
Level: Level 2

Topic: Foreign exchange risk and currency risk management

FM – L2 – Q87 – Foreign exchange risk and currency risk management

Explain four differences between forward and futures contracts for AB Enterprises.

Question

AB Enterprises, a company whose domestic currency is the cedi, has imported a consignment of tomato paste from Spain at a cost of EUR540,000, which is payable in three months’ time. Ama Kofi, the company’s finance director, is concerned about the company’s exposure to currency risk, and she is considering the use of forward contracts or currency futures to hedge the risk.

Required:
(i) Explain to Ama Kofi FOUR differences between a forward contract and a futures contract.
(ii) Currency risk exposure may be transaction risk, economic risk, or translation risk. Which of the three kinds of currency risk exposure is AB Enterprises facing in relation to the EUR540,000 tomato paste consignment?
(iii) Explain to Ama Kofi, THREE disadvantages of hedging the euro exposure with futures hedge.

Answer

Find Related Questions by Tags, levels, etc.

Tags: Basis risk, Currency Risk, Financial instruments, Forward contracts, Futures contracts, Futures hedging, Hedging, Transaction risk
Level: Level 2

Topic: Futures and hedging with futures

Tag (SQ): Transaction risk

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FM – L2 – Q98 – Foreign exchange risk and currency risk management

Accra Food and Beverage Co hedges USD189,000 net liability using forward and money market methods.

FM – L2 – Q91 – Foreign Exchange Risk Management

Explain how a UK company can hedge USD payment risk using a forward contract and calculate the sterling cost in 3 months.

FM – L2 – Q87 – Foreign exchange risk and currency risk management

Explain four differences between forward and futures contracts for AB Enterprises.

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FM – L2 – Q98 – Foreign exchange risk and currency risk management

Accra Food and Beverage Co hedges USD189,000 net liability using forward and money market methods.

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FM – L2 – Q91 – Foreign Exchange Risk Management

Explain how a UK company can hedge USD payment risk using a forward contract and calculate the sterling cost in 3 months.

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FM – L2 – Q87 – Foreign exchange risk and currency risk management

Explain four differences between forward and futures contracts for AB Enterprises.

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