Medium2 marksShort Answer

Risk ManagementRisk managementForeign exchange riskPurchasing Power ParitySection B

This question is part of a case study — click to read the full scenario(Case 26)

Section B - Case 3: Nexus Co

Nexus Co is a UK-based manufacturer of specialized robotics. The company exports to Europe and imports components from Japan. The home currency is the GBP (£).

Nexus Co is due to receive €500,000 from a European customer in 3 months.
Exchange rates available:
Spot rate (EUR/GBP): 1.1520 - 1.1560
3-month forward rate (EUR/GBP): 1.1450 - 1.1500

If Nexus Co uses a forward market hedge, what will be the guaranteed GBP receipt?

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ACCA · Question 28 · Risk Management

Section B - Case 3: Nexus Co

Nexus Co is forecasting exchange rates for its strategic planning.
The current spot rate is ¥160 / £1.
Annual inflation in the UK is expected to be 3%.
Annual inflation in Japan is expected to be 1%.

Using Purchasing Power Parity (PPP), calculate the expected spot rate in one year's time (¥ per £1). (Round to two decimal places).

How to approach this question

Use the PPP formula: S1 = S0 * [(1 + hc) / (1 + hb)], where hc is the inflation rate of the quote currency (Japan) and hb is the inflation rate of the base currency (UK).

Full Answer

Purchasing Power Parity formula: S1 = S0 * [(1 + Inflation_foreign) / (1 + Inflation_home)] Here, the quote is ¥ per £. So Japan is the foreign/quote currency, UK is the home/base currency. S1 = 160 * [(1 + 0.01) / (1 + 0.03)] S1 = 160 * [1.01 / 1.03] S1 = 160 * 0.98058 S1 = 156.893 (rounds to 156.89).

Common mistakes

Putting the UK inflation on top and Japanese on the bottom, resulting in 163.11.

Question 27 All questions Question 29

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