ICAEW - ACA - F.M Assessing financial risk and foreign trade Hedging Exam Questions and Answers 2023/2024

ICAEW - ACA - F.M Assessing financial risk and foreign trade Hedging Exam Questions and Answers 2023/2024 Foreign exchange risk - correct answer transaction risk Transaction risk - correct answer the risk that an exchange rate will change between the transaction date and the subsequent settlement date i.e. It is the gain or loss arising on conversion. What does transaction risk occur on - correct answer Imports and exports? Give an example of transaction risk on imports part 1 - correct answer for example, a firm enters into a contract on 1 January to buy a piece of equipment from the US for $300,000. The invoice is to be settled on 31 March. The exchange rate on 1st January is $1.6/£ therefore the firm expects the cost to be £187,500. However, by 31st March, the pound may have strengthened or depreciated When importing if pound strengthens - correct answer cost falls When importing if pound depreciates - correct answer cost rises Economic risk - correct answer the variation in the value of the business i.e. The present value of future cash flows due to unexpected changes in exchange rates. It is the long-term version of transaction risk. For an export company it could occur because - correct answer the home currency strengthens against the currency in which it trades or a competitor's home currency weakens against the currency in which it Trades. What is a solution to this - correct answer A favoured, but long term solution, is to diversify all aspects of the business internationally Translation risk - correct answer Where the reported performance of an overseas subsidiary in homebased currency terms is distorted in consolidated financial statements because of a change in exchange rates. N.B. This is an accounting risk rather than a cash based one. Exchange rates - Quoted exchange rates - correct answer Banks dealing in foreign currency quote two prices a 'spread' for an exchange rate: a lower 'offer' price and a higher 'bid' price. The lower rate, - correct answer is the rate at which the dealer will sell the variable currency US dollars in exchange for the base currency sterling. The higher rate - correct answer is the rate at which the dealer will buy the variable currency US dollars in exchange for the base currency sterling. Why is this - correct answer The bank will always trade at the rate that is more favourable to itself. Managing transaction risk - practical solutions - correct answer When currency risk is significant for a company, it should do something to either eliminate it or reduce it. Doing nothing may mean that the wins and losses even out in the long run, however for a significant transaction, the risk is large enough to be a problem.