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ACCA Strategic Professional · Advanced Financial Management · The use of financial derivatives to hedge against forex risk

Kestrel plc, a UK company, has signed a contract to buy machinery from a US supplier, payable in US dollars in four months. Which type of foreign exchange exposure does this primarily create for Kestrel plc?

It is transaction exposure. Kestrel has a committed US dollar payment due in four months, so the sterling cost depends on the exchange rate at settlement. Translation exposure concerns restating foreign subsidiaries' accounts, and economic exposure concerns long-term competitiveness.

  1. ATransaction exposure, because a known foreign currency payment will be settled in the futureCorrect
  2. BTranslation exposure, because the machinery will be consolidated into the group accounts
  3. CEconomic exposure, because long-term competitiveness will change permanently
  4. DPolitical exposure, because the supplier is located abroad

Explanation

A committed future payment in a foreign currency exposes the company to changes in the exchange rate between contract date and settlement. This is transaction exposure. Translation exposure relates to restating foreign net assets or results, not a specific payment. Economic exposure concerns long-term cash flow competitiveness.

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