Easy2 marksMultiple Choice

Risk ManagementRisk managementForeign exchange riskSection B

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

Section B - Case 3: GlobalLogix

Scenario: GlobalLogix is a cross-border logistics firm based in the Eurozone (€). The company expects to receive $2,000,000 from a US client in 3 months' time.
Current spot rate ($/€): 1.1500 - 1.1550
3-month forward rate ($/€): 1.1600 - 1.1660
Eurozone interest rates: Borrow 2.0% per year, Deposit 1.0% per year.
US interest rates: Borrow 4.0% per year, Deposit 3.0% per year.

If GlobalLogix uses a forward contract to hedge this receipt, how many Euros (€) will they receive in 3 months?

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ACCA · Question 28 · Risk Management

Section B - Case 3: GlobalLogix

Scenario: GlobalLogix is a cross-border logistics firm based in the Eurozone (€). The company expects to receive $2,000,000 from a US client in 3 months' time.
Current spot rate ($/€): 1.1500 - 1.1550
3-month forward rate ($/€): 1.1600 - 1.1660
Eurozone interest rates: Borrow 2.0% per year, Deposit 1.0% per year.
US interest rates: Borrow 4.0% per year, Deposit 3.0% per year.

The risk that the $2,000,000 receipt will be worth fewer Euros than expected when it is actually converted in 3 months is an example of which type of foreign exchange risk?

Answer options:

Translation risk

Economic risk

Transaction risk

Basis risk

How to approach this question

Identify the risk associated with a specific, short-term cash flow settlement.

Full Answer

C.Transaction risk✓ Correct

Foreign exchange risk is categorized into three types: 1. Transaction risk: The risk of adverse exchange rate movements occurring in the course of normal international trading transactions (e.g., waiting 3 months to be paid). 2. Translation (accounting) risk: The risk that the consolidated financial statements will be affected by exchange rate changes when translating foreign subsidiary accounts. 3. Economic risk: The long-term risk that changes in exchange rates will alter the international competitiveness of a company.

Common mistakes

Confusing transaction risk with economic risk.

Question 27 All questions Question 29

Practice the full ACCA FM — Financial Management Practice Exam 4

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