CIMA F3 Syllabus C. Financial risks - Understanding Exchange Rates - Notes ^{1 / 5}

£ : $1.5

Here £ = Base Currency; $ = Counter Currency

£0.67:$

Here $ = Base Currency; £ = Counter currency

Normally the “foreign” currency is the counter currency

Banks BUY HIGH and SELL LOW

Here we are referring to the foreign / counter currency

If a company needs to make a foreign currency payment

• Banks SELL the foreign currency at the LOWER rate

If a company needs to make a foreign currency receipt

• Banks will BUY that foreign currency from them at the HIGHER rate

Illustration:

The spot rate for GBP is £/CAD 1.4394 – 1.4587. The three-month forward premium is 0.0170 – 0.0220.

If you wanted to sell your CAD forward, what exchange rate would the bank offer you?

A bank buys high and sells low so the appropriate spot rate is 1.4587.

A premium should be deducted. 1.4587 – 0.0220 = 1.4367.

Translating Currencies

1. If you are given the counter currency:

   DIVIDE the amount by the exchange rate

   Eg A UK company has to pay $1,500.
   £ : $1.5
   Solution = $1,500 / 1.5 = £1,000

2. If you are given the Base currency:

   MULTIPLY the amount by the exchange rate

   Eg A UK company has to pay £1,000 in $.
   £ : $1.5
   Solution = £1,000 x 1.5 = $1,500

If £ is strong (strengthening, appreciate)

• UK exporters suffers because the $ is weak and their revenues is in $s.

• If the £ appreciates relative to the $, the exchange rate falls: 

  it takes fewer £ to purchase $1. 

  ($1 = £1.5  → $1= £1.4).

If £ is weak (weakening, depreciate, devalue)

• UK importers suffer because the $ is strong and their costs are in $s.

  Translation risk 
  - NCA and CA value - decrease
  - NCL and CL value - increase.

• For instance, if the £ depreciates relative to the $, the exchange rate rises: 

  it takes more £ to purchase $1. 

  ($1= £1.5 → $1= £1.7).