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Tutorial 3

The document contains a tutorial with true/false questions, multiple-choice questions, and fill-in-the-blank exercises related to foreign exchange concepts. It covers topics such as forward contracts, hedging, exchange rate systems, and foreign currency options. Additionally, it includes a problem-solving section involving a case study of a U.S. company hedging against exchange rate risk.

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Habiba Mohammed
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9 views7 pages

Tutorial 3

The document contains a tutorial with true/false questions, multiple-choice questions, and fill-in-the-blank exercises related to foreign exchange concepts. It covers topics such as forward contracts, hedging, exchange rate systems, and foreign currency options. Additionally, it includes a problem-solving section involving a case study of a U.S. company hedging against exchange rate risk.

Uploaded by

Habiba Mohammed
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Tutorial 3

Q1) True or False


1. The forward exchange rate is always equal to the spot rate.
Answer: False

2. A put option gives the holder the right to buy foreign currency.
Answer: False

3. A foreign currency option contract gives the holder the obligation to trade
foreign currency at a specified rate.
Answer: False

4. Hedging foreign exchange risk is primarily done using forward contracts and
options.
Answer: True

5. The independent float system allows a currency’s value to fluctuate freely


based on supply and demand.
Answer: True

6. Companies engaged in international trade are never exposed to foreign


exchange risk.
Answer: False

7. Foreign exchange gains or losses occur when there is a change in the


exchange rate between the transaction date and the settlement date.
Answer: True
Q2) MCQ
1. Which of the following best describes a pegged exchange rate system?
a) The currency value is allowed to fluctuate freely.
b) The currency value is fixed in terms of another currency.
c) The currency is backed by gold reserves.
d) The currency fluctuates based on supply and demand

Answer: b

2. A company that purchases goods from a foreign supplier and pays in the
supplier's currency is exposed to:
a) Transaction exposure
b) Translation exposure
c) Economic exposure
d) No exposure

Answer: a

3. In hedge accounting, fair value hedges result in:


a) Gains and losses recorded in other comprehensive income
b) Gains and losses recorded immediately in net income
c) Gains and losses deferred until the hedge is settled
d) No impact on financial statements

Answer: b

4. A forward contract is best used to:


a) Speculate on currency fluctuations
b) Reduce transaction exposure
c) Guarantee a fixed exchange rate for future transactions
d) Both (b) and (c)
Answer: d
5. What happens if a U.S. company sells goods to a European customer and the
euro depreciates before payment is received?
a) The company will receive more U.S. dollars than expected.
b) The company will receive fewer U.S. dollars than expected.
c) There is no impact on the company’s revenue.
d) The exchange rate risk is eliminated automatically.

Answer: b

6. A foreign currency transaction that is settled at a later date than the


transaction date is exposed to:
a) Credit risk
b) Market risk
c) Foreign exchange risk
d) No risk

Answer: c

7. If a foreign currency forward rate is higher than the spot rate, the currency is
trading at a:
a) Discount
b) Premium
c) Parity
d) Fixed exchange rate

Answer: b
8. Under hedge accounting, gains or losses on a fair value hedge are recorded
in:
a) Other comprehensive income
b) Retained earnings
c) Net income
d) Deferred tax liabilities

Answer: c

Q3) Complete the sentence:

1. The __________ exchange rate is the price for purchasing or selling a


foreign currency today

Answer: Spot

2. A ___________ option gives the holder the right to sell foreign currency at a
predetermined exchange rate.

Answer: Put

3. A __________ contract is an agreement to exchange currency at a future


date for a predetermined rate.

Answer: Forward

4. Foreign currency transactions must be recorded at the __________rate on


the transaction date.

Answer: Spot

5. A foreign currency hedge is used to protect against ___________.

Answer: Exchange rate fluctuations


6. If a foreign currency forward rate is less than the spot rate, the currency is
trading at a ________.

Answer: Discount

Q4) Problems

1. EchCorp, a U.S. company, sells goods to a German customer on Dec 1, Year


1 for €500,000. The payment is due on April 1, Year 1. To hedge against
exchange rate risk, TechCorp enters a forward foreign currency contract on
July 1, Year 1, agreeing to sell €500,000 at a forward rate of $1.17 per euro
on April 1, Year 1.
- Spot rate on Dec 1, Year 1: $1.20 per euro
- Spot rate on Dec 31, Year 1: $1.18 per euro
- Forward rate on Dec 31, Year 1: $1.165 per euro
- Spot rate on April 1, Year 1: $1.15 per euro
- Annual interest rate: 6% (0.5% per month)

Answer:

Date Spot Forward


12/1 1.20 1.17
31/12 1.18 1.165
1/4 1.15 1.15

Dec. 1 year 1

Accounts Receivables (500,000 x 1.20) 600,000

Sales 600,000
Dec.31 year 1

Step 1: Calculate foreign exchange gain or loss

= (1.20 – 1.18) x 500,000 = 10,000

Foreign exchange loss 10,000

Accounts receivables 10,000

Step 2: Calculate gain/ loss on forward contract by using interest rate

(1.165 – 1.17) x 500,000 = 2,500

Discount factor = Fair value/ 1+interest rate

2,500/ (1+0.005) = 2,488

Step 3: Journal Entry of Dec. 31

Foreign Exchange loss 10,000

Accounts Receivables 10,000

Forward Contract 2,488

Gain on forward contract 2,488

April 1:

Step 1: Calculate foreign exchange gain or loss

(1.18 – 1.15) x 500,000 = 15,000

Foreign exchange loss 15,000

Accounts Receivables 15,000


Forward Contract 12,488

Gain on forward contract 12,488

Step 2: Payment

Foreign currency (500,000 x 1.15) 575,000

Accounts receivables 575,000

Cash (500,000 x 1.17) 585,000

Foreign currency 575,000

Forward contract 10,000

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