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Which of the following statements are true if IRPT is used to forecast forward value of the dollar for the transaction in 6 months time (assuming interest rates stay same)
a) Value of dollar will be forecast to rise compared to spot rate – leading to fall in cost of transaction
b) Value of dollar will be forecast to rise compared to spot rate – leading to rise in cost of transaction
c) Value of dollar will be forecast to fall compared to spot rate – leading to rise in cost of transaction
d) Value of dollar will be forecast to fall compared to spot rate – leading to fall in cost of transactionSir correct answer is a) , can you please explain me why this is correct answer?
The ‘home’ currency is the dollar. Since the euro interest rates are higher than the dollar interest rates, the euro per $ exchange rate will increase (looking at the interest rate parity formula). Therefore there are more euros to the $, which means the value of the $ has increased.
Sir value of dollar will increase, this I have understood. But how this will lead to fall in cost of transaction, this I do not get in my mind?
Also which cost of transaction they are talking about?The question specifically refers to the transaction in 6 months time, which is the payment in euros. (The receipt in dollars is not at risk because the company’s home currency is dollars)
Since the dollar is stronger, the cost of a payment in euros will be lower for them.
Sir as you said that The receipt in dollars is not at risk because the company’s home currency is dollars.
So basically here you are referring to invoicing in home currency which is 1 of the way to hedge exchange rate risk.
But still in invoicing in home currency we still face the inflation risk (i.e upward or downward movement ) of inflation, so do we ignore this risk?
I am not referring to invoicing in anything.
The question specifically says that they work in $’s and that there is a receipt in dollars.
The question is specifically asking about what will happen to the value of the dollar using interest rate parity. Inflation has nothing at all to do with it.
Sir as I asked you earlier that value of dollar will increase, this I have understood. But how this will lead to fall in cost of transaction, this I do not get in my mind? Also which cost of transaction they are talking about?
And as you replied earlier that the question specifically refers to the transaction in 6 months time, which is the payment in euros. (The receipt in dollars is not at risk because the company’s home currency is dollars)
Suppose here the receipt instead in dollars was also in euros, then would we have considered the receipt before coming to the conclusion that
“Value of dollar will be forecast to rise compared to spot rate – leading to fall in cost of transaction.”
OR
Would we still just have considered 300000 payment in euros before coming to the conclusionYou ask which cost they are talking about – I have kept repeating that the only transaction at risk due to exchange rate changes in 6 months time is the payment in euros.
If the $ strengthens then the cost when converted to $’s of the euro payment will be lower.
If the receipt in 6 months time was in euros, then that is not a cost – it is a receipt and if the $ strengthens then the receipt when converted to $’s will be lower.
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