Foreign Currency Transactions and Hedging

Foreign exchange risk

part (2)
• In order to avoid the Risk that results from
changing the Exchange Rate, The Company
(Exporter or Importer) may sign a contract with
the Bank (Forward Contract) to sell or buy the
Foreign Currency in the future at a Forward
Rate.
• In this Case, Both the Company and the Bank
have to implement the contract in the future at
the Forward Rate (Rate stated in the Contract).
• It means that the difference between the
Forward Rate at the date of the contract and
the Forward Rate at the date of Paying or
Receiving the Foreign Currency may be Gain or
Loss depending on the type of the transaction
as follows
Changes in Exchange

Transaction Currency Contract

Increase  Decrease 

Export (Sale) Forward Sale Contract Loss Gain

Forward Purchase
Import (Purchase)
Contract
Gain Loss
Remember that: the difference between the
Exchange (Spot) Rate at the date of the
transaction and the Exchange Rate at the date
of Paying or Receiving the Foreign Currency
may be Gain or Loss depending on the type of
the transaction as follows
Changes in Exchange
Transaction Goods Contract
Increase  Decrease 

Export (Sale) Accounts Receivable (AR) Gain Loss

Import (Purchase) Accounts Payable (AP) Loss Gain

• On December 1, 2007, a U.S Firm Sold inventory on account for
500,000 euros. The amount is receivable on March 1, 2008.
• On December 1, 2007, the U.S Firm entered into a Forward
Contract to sell 500,000 euros on March 1, 2008 for $1.052. The
exchange rates between Dollars and Euros were as follows:

Date Spot Rate Forward Rate

December 1, 2007 1.05 1.052

December 31, 2007 1.055 1.059

March 1, 2008 1.07  

• Required:
• Record the transactions in the records of the U.S Company Records.
• Show the effect on Income Statement and Balance Sheet at December 31,
2007.
• On December 1, 2007, a U.S Firm Purchased inventory on
account for 500,000 euros. The amount is payable on March 1,
2008.
• On December 1, 2007, the U.S Firm entered into a Forward
Contract to buy 500,000 euros on March 1, 2008 for $1.052. The
exchange rates between Dollars and Euros were as follows:
Date Spot Rate Forward Rate

December 1, 2007 1.05 1.052

December 31, 2007 1.055 1.059

March 1, 2008 1.07  

• Required:
• Record the transactions in the records of the U.S Company Records.
• Show the effect on Income Statement and Balance Sheet at December
31, 2007.