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
