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International Finance Questions-Foreign Exchange Rate

Q11-1 Explain the difference between indirect and direct exchange rates.

Q11-2 What is the direct exchange rate if a U.S. company receives $1.3623 in Canadian currency in exchange for $1.00 in U.S. currency?

Q11-3 The U.S. dollar strengthened against the European euro. Will imports from Europe into the United States be more expensive or less expensive in U.S. dollars? Explain.

Q11-4 Differentiate between a foreign transaction and a foreign currency transaction. Give an example of each.

Q11-5 What types of economic factors affect currency exchange rates? Give an example of a change in an economic factor that results in a weakening of the local currency unit versus a foreign currency unit.

Q11-6 How are assets and liabilities denominated in a foreign currency measured on the transaction date? On the balance sheet date?

Q11-7 When are foreign currency transaction gains or losses recognized in the financial statements? Where are these gains or losses reported in the financial statements?

Q11-8 Sun Company, a U.S. corporation, has an account payable of $200,000 denominated in Canadian dollars. If the direct exchange rate increases, will Sun experience a foreign currency transaction gain or
loss on this payable?

Q11-9 What are some ways a U.S. company can manage the risk of changes in the exchange rates for foreign currencies?

Q11-10 Distinguish between an exposed net asset position and an exposed net liability position.

Solution Preview

Q11-1 Explain the difference between indirect and direct exchange rates.
A direct exchange rate is home currency per unit of foreign currency.
An indirect exchange rate is foreign currency per unit of home currency.
A "direct" quotation is the amount of domestic currency (dollars and cents in the United States) per unit of foreign currency. Example: $2.0676 / £ in US.
An "indirect" quotation is the amount of foreign currency per unit of domestic currency (per dollar in the United States). Example: 0.8251 Euro/$ in US

Q11-2 What is the direct exchange rate if a U.S. company receives $1.3623 in Canadian currency in exchange for $1.00 in U.S. currency?

A direct exchange rate is home Currency / 1 unit of foreign currency.
Here the home currency is USD
Therefore, direct exchange rate = (1/ 1.3623) USD / CAD = 0.7341 USD / CAD

Q11-3 The U.S. dollar strengthened against the European euro. Will imports from Europe into the United States be more expensive or less expensive in U.S. dollars? Explain.

If the US dollar strengthens (appreciates) against the Euro, then imports from Europe into the United States will be less expensive in US dollar terms. This is because 1 US dollar can buy more Euros after the appreciation of the currency. Since imports are invoiced in Euros, it means that the imports will cost less in US dollar terms.

Example: Let a computer imported from Europe be priced at EUR 1,000.
Let the USD appreciate from USD 0.9500/ EUR to USD 0.9300/EUR. (USD is appreciating against EUR because 1 EUR could buy USD 0.9500 before appreciation of the USD and only USD 0.9300 after the appreciation)
Before the appreciation, the computer costs USD 1,000 x 0.9500 = ...

Solution Summary

Answers to International Finance Questions dealing with direct and indirect exchange rates, foreign transaction, foreign currency transaction, factors affecting currency exchange rates, measurement of assets and liabilities denominated in a foreign currency, recognition of foreign currency transaction gains or losses, management of the risk of changes in the exchange rates for foreign currencies, difference between an exposed net asset position and an exposed net liability position.

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