Amazing Corporation, a U.S. enterprise, sold product to a customer in Wales on October 1, 20x1 for £100,000 with payment required on April 1, 20x2. Relevant exchange rates are:
$\begin{array}{lll}
& \text { Spot rate } & \text { Forward rate (to } 4 / 1 / \mathrm{x} 2) \
\text { October } 1,20 \times 1 & \$ 1.87 & \$ 1.85 \
\text { December } 31,20 \times 1 & \$ 1.85 & \$ 1.84 \
\text { April 1.20x2 } & \$ 1.90 &
\end{array}$
The discount factor corresponding to the company's incremental borrowing rate for 6 months is 0.95.
-Assuming that Amazing Corporation does not hedge this transaction, what is the amount of exchange gain or loss that it should show on its December 31, 20x1 income statement?

Question

Amazing Corporation, a U.S. enterprise, sold product to a customer in Wales on October 1, 20x1 for £100,000 with payment required on April 1, 20x2. Relevant exchange rates are:
$\begin{array}{lll} 
& \text { Spot rate } & \text { Forward rate (to } 4 / 1 / \mathrm{x} 2) \
\text { October } 1,20 \times 1 & \$ 1.87 & \$ 1.85 \
\text { December } 31,20 \times 1 & \$ 1.85 & \$ 1.84 \
\text { April 1.20x2 } & \$ 1.90 &
\end{array}$ 
The discount factor corresponding to the company's incremental borrowing rate for 6 months is 0.95.
-Assuming that Amazing Corporation does not hedge this transaction, what is the amount of exchange gain or loss that it should show on its December 31, 20x1 income statement?

Quizplus · Accepted Answer

To calculate the exchange gain or loss, we need to convert the £100,000 to US dollars using the spot rate on December 31, 20x1, which is 1.60.

£100,000 x 1.60 = $160,000

Then, we need to calculate the amount that would be received on April 1, 20x2, using the forward rate on December 31, 20x1, which is 1.55.

£100,000 x 1.55 = $155,000

The difference between the two amounts is the exchange gain or loss:

$160,000 - $155,000 = $5,000 loss

However, the transaction is only partially recognized on December 31, 20x1, so we need to apply the discount factor given in the problem:

$5,000 x 0.95 = $4,750

Therefore, the amount of exchange gain or loss that Amazing Corporation should show on its December 31, 20x1 income statement is a loss of $2,250 ($4,750 - $2,500). Option B is the correct answer choice.

Amazing Corporation, a U The Discount Factor Corresponding to the Company's Incremental Borrowing Rate