Question

A French company wants to invest 20 million euros for three months. The company found that investing in a Thai money market account would give it a higher interest rate than domestic investments. Which of the following is true about this investment?A. The investment is risk-free because money market investments are considered to be equivalent to bank deposits.B. The investment is not risk-free because foreign currency movements in the intervening period can affect the profitability of the firm.C. The investment is risk-free because such investments also lock foreign exchange rates for the duration of the investment.D. The investment is not risk-free because money market instruments are considered to be the most speculative of all investments.E. The investment is risk-free because the Thai money market is considered to be more stable and secure than other markets

Answer 1

Answer: B.The investment is not risk free because foreign currency movements in the intervening period can affect the profitability of the firm

Explanation:

The investment is not risk free because foreign currency movements in the intervening period can affect the profitability of the firm.

The domestic interest rate must be lower than foreign interest rate plus percentage difference between current exchange rate and expected exchange rate for a domestic firm to choose investing in a foreign country.

Rthai + E* - E)/E must be greater than France

Rthai = interest rate in Thai

E* = expected exchange rate

E = current exchange rate

Rfrance = interest rate in France

The return on foreign investments is affected by foreign exchange currency movements

Answer 2

Answer:

The correct answer is B. The investment is not risk-free because foreign currency movements in the intervening period can affect the profitability of the firm.

Explanation:

Currency risk is the positive or negative difference that arises from changes in the exchange rate over time. A company that performs operations in another currency is exposed to foreign exchange movements, therefore it must seek to compensate them strategically.

Whenever a company carries out a transaction in foreign currency, whether it is for the importation of inputs or products, or for the export of goods, with a waiting period between collection and payment, there is a risk of loss or gain that may affect to your finances and your profitability.

The types of foreign exchange risk

The foreign exchange risk that a company may face has to do with the nature of the operation carried out and its temporality:

Transaction risk It occurs in the short term when the commercial activities of the organization require buying or selling currencies to make a payment, either for the acquisition of products or for the fulfillment of the financial obligations contracted.

Economic risk It is presented in the long term when the commercial transaction extends over time and influences the company's profitability, causing its market value to vary.

Translation risk. It is reflected in accounting aspects when repatriation of the profits or losses of subsidiaries of the company located abroad is made to incorporate them into the financial statements of the parent.

As the exchange market is volatile, a company that does not anticipate changes in the exchange rate may run the risk of incurring losses that affect its financial planning and cash flows.

Therefore, it is advisable to be prudent in your purchases of raw materials or finished products and in the contracting of financing in other denominations.

Even though large consortiums can count on the natural coverage that arises from the compensation of the losses they have in some markets with the profits of others, it is not common for most companies.