ExpertMedium2 marksShort Answer
ACCA · Question 18.5 · Risk Management
CASE 3: GLOBALBEAN CO
GlobalBean Co is a coffee exporter based in the US (reporting in USD). The company frequently sells coffee beans to European buyers, invoicing in Euros (EUR). GlobalBean expects to receive EUR 500,000 in three months. The company is concerned about foreign exchange risk and interest rate risk on a floating rate loan it holds.
GlobalBean is forecasting exchange rates for next year. The current spot rate is 1.2000 USD/EUR. Annual inflation is expected to be 3% in the US and 1.5% in the Eurozone.
Using Purchasing Power Parity (PPP), calculate the expected spot rate in one year (USD/EUR).
(Enter your answer to four decimal places, e.g., 1.2345)
CASE 3: GLOBALBEAN CO
GlobalBean Co is a coffee exporter based in the US (reporting in USD). The company frequently sells coffee beans to European buyers, invoicing in Euros (EUR). GlobalBean expects to receive EUR 500,000 in three months. The company is concerned about foreign exchange risk and interest rate risk on a floating rate loan it holds.
GlobalBean is forecasting exchange rates for next year. The current spot rate is 1.2000 USD/EUR. Annual inflation is expected to be 3% in the US and 1.5% in the Eurozone.
Using Purchasing Power Parity (PPP), calculate the expected spot rate in one year (USD/EUR).
(Enter your answer to four decimal places, e.g., 1.2345)
How to approach this question
Apply the PPP formula: Expected Spot = Current Spot × ((1 + Inflation of Quote Currency) / (1 + Inflation of Base Currency)). Here, EUR is the base currency.
Full Answer
The PPP formula is S1 = S0 × ((1 + hc) / (1 + bc)), where hc is the inflation rate of the quote currency (USD) and bc is the inflation rate of the base currency (EUR).
S1 = 1.2000 × (1 + 0.03) / (1 + 0.015)
S1 = 1.2000 × (1.03 / 1.015)
S1 = 1.2000 × 1.014778 = 1.21773...
Rounding to four decimal places gives 1.2177.
Common mistakes
Putting the Eurozone inflation in the numerator, resulting in 1.1825.
Practice the full ACCA FM — Financial Management Practice Exam 3
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