Question 1

Section B - Case 3: LithiumX

Scenario: LithiumX is a cross-border mining company based in the US. It expects to receive €2,000,000 in exactly 3 months from a European client. 
Spot exchange rate: €1.1500 - €1.1550 / $1
3-month forward rate: €1.1600 - €1.1640 / $1
US interest rates: 4% borrow, 2% deposit (annual)
Euro interest rates: 5% borrow, 3% deposit (annual)

LithiumX is also bidding on a new contract in Japan. If they win the contract, they will receive ¥500 million in 6 months. If they lose, they receive nothing. The contract award date is in 1 month.

Question: Which hedging instrument is most appropriate for the potential Japanese Yen receipt?

Accepted Answer

Identify the nature of the cash flow. It is contingent (uncertain). Forward contracts and money market hedges are binding. Options provide flexibility for uncertain cash flows.

Question 2

What mistakes do candidates make on this ACCA question?

Accepted Answer

Selecting a forward contract because it is the most common hedging tool, ignoring the 'contingent' nature of the cash flow.

How to approach this question

Full Answer

Common mistakes

Practice the full ACCA FM — Financial Management Practice Exam 6

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