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Dear sir,
I had a doubt in Foreign currency risk regarding changes in exchange rates.There’s a qn in the BPP reader which goes like this
Bulldog Ltd, a UK company, buys goods from Redland which cost 100,000 Reds (the local currency). The goods are resold in the UK for £32,000. At the time of the import purchase the exchange rate for Reds against sterling is Red3.5650 – Red3.5800 per £1. Required
(a) What is the expected profit on the resale?
b) What would the actual profit be if the spot rate at the time when the currency is received has moved to:
(i) Red3.0800 – Red3.0950 per £1?
ii) Red4.0650 – Red4.0800 per £1?
Ignore bank commission charges.Now my understanding is if the company needs the foreign currency to pay Redland, the bank has to sell them the currency at the selling rate, however to calculate the conversion amount the book has shown it as say, 100,000 Reds divided by 3.5650
Isn’t that the buying rate? Also, since the selling rate is always higher than the buying rate, wouldn’t that be the basis of finding out which is buying & which is selling rate out of the exchange rate?
I hope you can help me with this query.
Thanks!Calling the rates buy rates or sell rates depends on whether we are referring to the rate at which the company buys and sells, or the rate at which the bank buys and sells (and also, of course, which currency is being quoted against the other).
I do suggest that you watch my free lectures on foreign exchange risk where I explain in detail (with examples) which rate to use, and why.
In this question, the exchange rate to use is indeed 3.5650. It is whichever rate is worse for the company (it is the bank that makes the profit from the spread) and converting at 3.5650 will mean a higher payment by the company than converting at 3.5800.
(The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well)
Dear sir,
I think I’ve got it now.
So the first currency is the rate at which the company buys and and the second is the selling rate of the company and in reverse order for the banks. Am I right?I guess I might have overlooked the bank buying and selling rate given in some questions and assumed it to be the same as the spot exchange rate.
Thanks for helping me out!
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