Cost of machine on 1 st April = $90,000/1.50 = £ 6,000 On 30 th June the cost could be (i) $9,000/1.60 = £5,625 (ii) $9000/1.40 = £6428.57 (a) The firm would be exposed to transaction risk The effect of an exchange rate changes on outstanding obligations that existed before exchange rates changed but were settled after the change. (b) The financial implication of each case: Case i The pound appreciates to $1.60/£ Financial gain (£6,000 – 5,625) = £375 Case ii The pound depreciates to $1.40/£ Financial loss (£6,000 – 6,428 .57) = £428 .57 (c) Foreign exchange exposure management techniques - Forward exchange contract - Currency borrowing - Currency netting - Currency option - Currency swap - Currency futures Question 5 One of your bank’s customers is anxious to obtain supplies of Rentinus FMDXC from Indonesian throu gh a merchant in England. Your customer has compared prices in other parts of Europe, Asia and America. He discovered that prices from America, particularly the U.S.A, are relatively cheaper. He decided to accept the U.S.A quotation, despite the payment in advance terms.
62 Required: (a) An explanation of cash in advance mode of payment in international trade. (5 marks) (b) The risks it entails both to the exporter and the importer and how the risks can be mitigated. (10 marks) (Total = 15 marks) Comment The question tested candidates’ knowledge of method of payment, particularly payment in advance. As expected, 281 candidates, representing 92%, attempted the question, and 210 candidates passed, representing about 75% pass rate. This performance was not unexpected, considering the number of times this question has been tested. Moreover, most candidates were able to use their practical experience to suggest mitigation to risks associated with this method of payment to both the importer and exporter. Answer (a) Cash in advance mode of payment is where payment is received before ownership of goods is transferred from the exporter to the importer. It is used mostly for goods made to custom or where it is the seller’s market. (b) Disadvantages of Payment in Advance to Importer - It is not suitable where parties are located in an unfriendly environment. - Inferior goods may be shipped. - There could be adverse effect of exchange rate fluctuation. - Exporter may not deliver the goods as agreed. - Cash flow may be affected, because he/she has to pay in advance Disadvantages of Payment in Advance to exporter - Turnover may be affected, since not many buyers will be willing to pay in advance. - Profit will also be affected. - Goodwill will also be affected. - It could increase the liability of the exporter. How these risks could be mitigated - Forward exchange contract - Importer to call for some documents that will make exporter ship quality goods, e.g. third-party inspection certificate, certificate of analysis, Status enquiry should be raised on the exporter.
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- Summer '16
- Balance Sheet, Foreign exchange market