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Risk ManagementRisk managementForeign Exchange RiskForward Contracts
This question is part of a case study — click to read the full scenario(Case 26)

Section B - Case 3: GlobalCart

Scenario: GlobalCart is a UK-based cross-border e-commerce company. Its functional currency is the British Pound (GBP).
GlobalCart imports electronics from the US and exports them to Europe.
The company expects to receive EUR 500,000 in 3 months from European customers.
It also needs to pay USD 300,000 in 6 months to its US suppliers.

Question:
The risk that the GBP value of the EUR 500,000 receipt will fall between now and the settlement date in 3 months is known as what type of risk?

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ACCA · Question 27 · Risk Management

Section B - Case 3: GlobalCart

Scenario: GlobalCart is a UK-based cross-border e-commerce company. Its functional currency is the British Pound (GBP).
GlobalCart imports electronics from the US and exports them to Europe.
The company expects to receive EUR 500,000 in 3 months from European customers.
It also needs to pay USD 300,000 in 6 months to its US suppliers.

Question:
GlobalCart decides to hedge the EUR 500,000 receipt using a forward contract.
The current spot rate is EUR/GBP 1.1500 - 1.1540.
The 3-month forward premium is 0.0020 - 0.0015.

What forward rate will the bank offer GlobalCart to sell its Euros?

Answer options:

A.

1.1480

B.

1.1520

C.

1.1525

D.

1.1555

How to approach this question

Step 1: Choose the correct spot rate (the bank always wins, so if you are selling the foreign currency, the bank gives you the worst rate, which is the higher number in an indirect quote). Step 2: Adjust for the premium. If the premium numbers are falling (0.0020 to 0.0015), you subtract them from the spot rate.

Full Answer

C.1.1525✓ Correct
1. Identify the transaction: GlobalCart receives EUR and must sell them to the bank for GBP. 2. Choose the spot rate: The quote is EUR per GBP 1. The bank will give GlobalCart as few GBP as possible, meaning it divides by the higher rate: 1.1540. 3. Adjust for forward points: The points are 0.0020 - 0.0015. Because the first number is larger than the second, it is a premium, meaning we SUBTRACT the points from the spot rate. 4. Calculation: 1.1540 - 0.0015 = 1.1525.

Common mistakes

Adding the points instead of subtracting them, or choosing the wrong side of the spread (1.1500).
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