Question

A U.S. firm buys merchandise today to a Japanese company for ¥100,000,000. The current exchange rate is ¥110.58/$, the account is receivable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to ¥110.13/$, the U.S. firm will realize a ________ of ________.a. translation gain; ¥3,695
b. translation loss; ¥3,695
c. transaction gain; $3,695
d. transaction loss; $3,695
e. None of the above is correct

Answer 1

Answer:

d. transaction loss; $3,695

Explanation:

Calculations:

Today  ¥110.58 can be exchanged by $1

US firm to pay today = 100,000,000/110.58 = 904322.66

US firm had to pay $904322.66 today.

US firm chooses to pay three months after the transaction and do not uses any hedging technique.

Three months later on settlement date  ¥110.13 can be exchanged by $1, so less  ¥ can be exchanged now than three months ago ( ¥110.58). Now US firm would incur transaction loss. Translation loss/gain occurs when balance sheet of a firm is converted from one currency to another.

US firm to pay 3 months later = 100000000/110.13 = 908017.79

US firm to pay $904322.66 three months later

Transaction gain/loss = $904322.66 - $908017.79 = -$3695.13

So US firm incurs loss of $3695.13, rounded off to $3695