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Foreign Exchange Risk Management – ACCA Financial Management (FM)

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  4. So, economic risk is more generic and can hardly be hedged against. You had better deal with a business whose country’s currency is relatively stable. But you can hedge against transaction risk since an amount has been set. You just need to view from the standpoint of the exporter or importer

  5. Sir …what is the difference between Transaction risk & Economic risk? Because I watched the lecture and what I got is that both of them is paying for goods at a later date, and exchange rate change by the time of payment>>>

    • Economic risk is 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.

  6. HI John,

    I had a resit in September and got 49%. There was a question on this and it was my weakest area in revision so I would like to become better at it.

    I understand the rule and know which rate to use, however the problem is when to divide and multiply when to divide.

    In question 1 we sold the USD for GBP but in question 2 we were also selling IR for R$ but we multiplied instead of divide. Before looking at the lecture I used divide which was wrong, I think I am missing something of when to divide and multiply.

    Can you help me here?

      • “we sold the USD for GBP but in question 2 we were also selling IR for R$”
        In Q1- we have the USD amount but in Q2- we have the R$ amount.

        Seems you’re both confusing with who is doing the buying and selling (company or the bank).
        Forget the bank for a minute and what it’s doing on it’s accounting books. (All the bank wants is a profit from changing your currency for you and that means whatever transaction we do with them, we will come off worse and thus we’ll either pay the bank more or receive less from them).

        So in Q1, UK is receiving US $100k. -> We have to convert that $100k to pounds. For every 拢1 we get $1.6 (clearly 拢 is stronger, as it gets more than 1$ for every 1拢).
        $ to 拢 -> 100k / exchange rate (using the higher exchange rate as bank wants a profit from our transaction)

        Q2) India is paying 240k Ruritania$ to Ruritania. -> Convert that Ruri$ to Indian Rupee (INR) to find out how much rupee will be needed to make the payment. For every R$1 we get about 9 Indian Rupees (here the Ruri$ is stronger, as it gets more than 1 INR for every 1R$)
        R$ to INR -> 240k x exchange rate (using the higher exchange rate as bank wants a profit from our transaction)

        (Hope this makes sense!)

      • If you want me to answer then you should ask in the Ask the Tutor Forum and not here.
        Your question has however been answered above, and it is all explained anyway in the free lecture.

    • They are buying R$ (and therefore selling IR) and so 9.2530 is the correct exchange rate to use.

      Think about it – if you converted at 8.6380 then they would have paid less, which cannot be right. It is always whichever rate is worse for the company (because it is the banks that make the profit out of the difference in the exchange rates).

      • This doesn’t make sense to me it seems to be contradicting.

        In example 1, we assume we are based in the UK, so the company receives money from a foreign customer, which we then sell to the bank at the higher rate of 1.6310. (The way I tend to remember this is the bank buys high and sells low).

        In example 2, we assume we are based in India, and are making a payment to a foreign supplier. This seems to be the opposite situation to example 1, as we are making payment rather than receiving it, yet you have still used the higher rate of 9.2530. As we have to buy from the bank to pay the Ruritarian dollars, wouldn’t we be buying this at the lower rate?

      • Think about it this way my dear,

        In the first example it was $/pound , we are receiving a foreign currency which need to be convert to our local currency so we will use the rate that provide us with the lower amount. ( if instead we used1.6250,it will provide u with higher amount)

        In example two, its look like its opposite situation but we are actually will need to sell the first currency as well but this time in order to make the payment in the foreign currency, so we will use the rate that provide us with the higher amount. ( if instead we used 8.6380,it will provide u with lower amount)

        I hope it does make sense to u now .

    • Jim Jam should have indian rupees, but he wants to pay R$. He has to buy the latter with his home currency. the bank would want him to multiply by the higher rate so they can collect from him more indian rupees. He is multiplying because he is working towards the second currency which is quoted as having higher value to his own currency.

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