ExpertMedium2 marksMultiple Choice
ACCA · Question 26 · Risk Management
Section B - Case 3: LithiumX
Scenario: LithiumX is a cross-border mining company based in the US. It expects to receive €2,000,000 in exactly 3 months from a European client.
Spot exchange rate: €1.1500 - €1.1550 / $1
3-month forward rate: €1.1600 - €1.1640 / $1
US interest rates: 4% borrow, 2% deposit (annual)
Euro interest rates: 5% borrow, 3% deposit (annual)
Question: If LithiumX uses a forward market hedge, what will be the guaranteed US Dollar ($) receipt in 3 months?
Section B - Case 3: LithiumX
Scenario: LithiumX is a cross-border mining company based in the US. It expects to receive €2,000,000 in exactly 3 months from a European client.
Spot exchange rate: €1.1500 - €1.1550 / $1
3-month forward rate: €1.1600 - €1.1640 / $1
US interest rates: 4% borrow, 2% deposit (annual)
Euro interest rates: 5% borrow, 3% deposit (annual)
Question: If LithiumX uses a forward market hedge, what will be the guaranteed US Dollar ($) receipt in 3 months?
Answer options:
A.
$1,739,130
B.
$1,724,138
C.
$1,718,213
D.
$2,328,000
How to approach this question
Determine whether to multiply or divide by the exchange rate. Since the quote is €/$, and you have €, you must divide. Then, choose the correct side of the spread: the bank always wins, so divide by the higher number to get fewer dollars.
Full Answer
C.$1,718,213✓ Correct
LithiumX is receiving Euros and needs to convert them to US Dollars.
The exchange rate is quoted as Euros per 1 US Dollar (€/$). To convert € to $, we must divide.
We must choose the rate from the forward spread: 1.1600 or 1.1640.
The rule is 'the bank always wins'. Dividing by the higher number (1.1640) gives the company fewer dollars, which is the bank's selling rate for dollars.
Calculation: €2,000,000 / 1.1640 = $1,718,213.
Common mistakes
Dividing by the lower rate (1.1600) or using the spot rate instead of the forward rate.
Practice the full ACCA FM — Financial Management Practice Exam 6
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