A U.S. firm sells merchandise today to a British company for £150,000. The current exchange rate is $1.55/£, the account is payable 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 $1.52/£ the U.S. firm will realize a ________ of ________.
A) loss; $4,500
B) gain; $4,500
C) loss; £4,500
D) gain; £4,500

Question

Quizplus · Accepted Answer

If the exchange rate changes from $1.55/£ to $1.52/£, then the British company will only have to pay $228,000 ($1.52/£ x £150,000). However, because the U.S. firm will receive payment in British pounds, the value of the payment in U.S. dollars will depend on the exchange rate at the time of payment, which is three months from now. If the exchange rate remains the same, the U.S. firm will receive $232,500 ($1.55/£ x £150,000). If the exchange rate changes to $1.52/£, then the U.S. firm will only receive $228,000 ($1.52/£ x £150,000). This represents a loss of $4,500 for the U.S. firm. Therefore, the correct answer is A.

A US Firm Sells Merchandise Today to a British Company for for £150,000