Question

Suppose you start with $100 and buy stock for £50 when the exchange rate is £1 = $2. One year later, the stock rises to £60. You are happy with your 20 percent return on the stock, but when you sell the stock and exchange your £60 for dollars, you only get $45 since the pound has fallen to £1 = $0.75. This loss of value is an example of _________

Answer 1

Answer:

The question is incomplete, the complete question is given below:

Suppose you start with $100 and buy stock for £50 when the exchange rate is £1 = $2. One year later, the stock rises to £60. You are happy with your 20 percent return on the stock, but when you sell the stock and exchange your £60 for dollars, you only get $45 since the pound has fallen to £1 = $0.75. This loss of value is an example of

A) exchange rate risk.

B) political risk.

C) market imperfections.

D) weakness in the dollar.

Answer:

Exchange rate risk

Explanation:

Exchange rate is the price of one currency in terms of another. In other words, it is the units of one currency that exchanges for another. Exchange rate between currencies could be volatile as it is affected by a number of factors ranging from inflation, interest rate risk, balance of payments e.t.c

Exchange rate risk :Fluctuations in exchange rate could lead to gains or losses for parties who conduct their transactions in the affected currencies.

For example, lets say Mr G  who resides in the UK imports $2000 worth of goods on January 2nd, 1999 when the exchange rate was $100 = £1 . The arrangement is that he will settle his supplier by January 25th, 1999.

As at the transaction date, his payables = $2000/100 = £20

Let us say by the settlement date, the rate is now $80 = £1

He would need to settle his liability with = $2000/80 = £ 25.

This is £5 more than it was when the transaction was done. Imagin what the loss would be if the transaction was worth $20 million !