Question

ABC Com.pany Inc, impor.ts equipment from BPD Company located in Germany. With the steady de.cline of the Can.adian dollar against the Euro ABC is finding a continued relation.ship with BPD to be incr.easingly difficult. In response to ABC's request, BPD has pro.posed the following risk-sharing arrangement. First, set the cu.rrent spot rate of C$1.30/€ as the base rate. As long as spot rates stay with.in 2.5% (up or down) ABC will p.ay at the base rate. Any rate out.side of the 2.5% range, BPD will share equally with ABC the diff.erence between the spot rate and the base r.ate. The agree.ment is for the next year .

At the next pay.ment in 2 months, what effective ex.change rate is paid in C dollars if the spot rate is C$1.32/€ and the s.ale is for 199,999€ ?

At the next pay.ment in 4 months, what effective ex.change rate is paid if the spot r.ate is C$1.38/€ and the s.ale is for 199,999€?

Answer 1

Question

Part 1: Effective exchange rate paid in C Dollars if spot rate is C$ 1.32/Euro (for the payment in next 2 months)

Solution:

Sharing arrangement will take effect only when the change in spot rate is beyond 2.5%

Spot rate after 2 months C$ 1.32/Euro

% change from the base rate( C$ 1.3/Euro) = (1.32 - 1.3) / 1.3 * 100

% change = 1.54%

Therefore ABC will pay BPd company at base rate (C$ 1.3/Euro)

hence, ABc will have to pay C$ 2,59,999 to BPD

Part 2 : Effective exchange rates paid if spot rate after 4 months is C$ 1.38/Euro

Solution :

% change in Exchange rate in exchange rate from base rate = (1.38 - 1.30) / 1.30 *100

% change = 6.15%

As the % upward change in the exchange rate is more than 2.5%, ABC and BPD will share the difference.

Hence, Payment to be made by ABC = Payment at base rate + .0.5(Change in the exchange rate)

Payment by ABc at base rate = Euros 1,99,999 * 1.3 = C$ 2,59,999

Payment by ABC (at half of the change in exchange rate) = Euros 1,99,999 * 0.5(1.38-1.3)

Payment for the change in exchange rate = C$ 8,000

Total Payment to be made by ABc to BPD = C$ 2,59,999 + C$ 8,000 = C$ 2,67,999

Share of BPD in the arrangement = C$ 8,000 (50% of loss to ABC)