CH 9.

Foreign Currency Transactions and

Hedging Foreign Exchange Risk
Foreign Currency Transactions

Foreign currency transactions are economic activities denominated in a

currency other than the entitys recording currency.

These transactions include the following:

1. Purchases or sales of goods or services (imports or exports), the prices of which
are stated in a foreign currency.
2. Loans payable or receivable in a foreign currency.
3. Purchase or sale of foreign currency forward exchange contracts.
4. Purchase or sale of foreign currency units.

Foreign currency exchange rates?

The rate at which one currency will be exchanged for another. It is also regarded as
the value of one countrys currency in relation to another currency (From Wikipedia)
1. How many USD must
be paid for a purchase
of maple syrup costing
5 CAD?
2. How many CAD are
required to purchase
goods costing 10 USD?
3. Weakening or
Strengthening of USD?
Foreign Currency Exchange Rates

Exchange rates change because of a number of economic factors affecting the

supply of and demand for a nations currency.

Factors causing fluctuations in exchange rates include:

1. Level of inflation
2. Balance of payments
3. Changes in interest rate
4. Changes in investment levels
5. Stability and process of governance
Handout 1-4

4. Upon arrival in Chile, Karen exchanged $1,000 of U.S. currency into

480,000 Chilean Pesos. While returning after her two month visit, she
exchanged her remaining 50,000 Pesos into $100 of U.S. currency. What
amount of gain or a loss did Karen experience on the 50,000 pesos she
held during her visit and converted to U.S. dollars at the departure date?

A. Loss of $4.
B. Gain of $4.
C. Loss of $6.
D. No gain or loss.
Foreign Currency Exchange Rates

Exchange rates change because of a number of economic factors affecting the

supply of and demand for a nations currency.

Factors causing fluctuations in exchange rates include:

1. Level of inflation
2. Balance of payments
3. Changes in interest rate
4. Changes in investment levels
5. Stability and process of governance

For financial statement purposes, transactions denominated in a foreign

currency must be translated into the currency the reporting company
uses at each balance sheet date.
Handout 1-5
Highland Company sold goods to an
December 6, 20X3 1 Egyptian pound = $0.1593
Egyptian company for 350,000 Egyptian
December 31, 20X3 1 Egyptian pound = $0.1612
pounds on December 6, 20X3, with
January 15, 20X4 1 Egyptian pound = $0.1604
payment due on January 15, 20X4.

5. Based on the preceding information, which of the following is true of

the dollars movement vis--vis the Egyptian pound during the period?

December 6 31 January 1 - 15
A. Dollar weakened Dollar strengthened
B. Dollar weakened Dollar weakened
C. Dollar strengthened Dollar strengthened
D. Dollar strengthened Dollar weakened
Handout 1-6
Highland Company sold goods to an
December 6, 20X3 1 Egyptian pound = $0.1593
Egyptian company for 350,000 Egyptian
December 31, 20X3 1 Egyptian pound = $0.1612
pounds on December 6, 20X3, with
January 15, 20X4 1 Egyptian pound = $0.1604
payment due on January 15, 20X4.

J/E on 12/6, 12/31, and 1/15?

6. Based on the preceding information, what is Highlands overall net gain
or net loss from its foreign currency exposure related to this transaction?
A. $280 loss
B. $302 loss
C. $385 gain
D. $665 gain
Spot Rate vs. Forward Rate

Spot Rate:
The exchange rate that is available today

Why?
Forward Rate:
1. The exchange rate that can be locked in today for an expected future
exchange transaction.
2. Expectations about the relative value of currencies are built into the forward
rate.
3. The actual spot rate at the future date may differ from todays forward rate.
Forward Exchange Rates

Example:
Assume a U.S.-based company purchases inventory for 1,000 on 3/31 and the
contract requires payment on 6/30.
Foreign Exchange Risk?
90-day
Forward rate = $1.40/

Spread = $0.05/
Spot rate = $1.35/

3/31 6/30 Risk?

Spot rate?
Forward Contract with Timeline

A forward contract requires the purchase (or sale) of currency units at a future date at
the contracted exchange rate.

10/1/X1 12/31/X1 4/1/X2

Transaction Balance sheet Settlement

date date date

Incur liability denominated in yen. Obtain yen by settling forward

exchange contract.
Sign 180-day forward exchange
contract to receive yen. Pay yen to settle account payable.