KK Ltd. operating in Japan has today affected sales to an Indian company LM Limited, the payment being due in 3 months from the date of invoice. The…
CA Final · Advanced Financial Management · PYQS · September 2025
KK Ltd. operating in Japan has today affected sales to an Indian company LM Limited, the payment being due in 3 months from the date of invoice. The invoice amount is 855 lakh yen which at today's spot rate is equivalent to 500 lakh. Looking to the present market conditions, it is anticipated that the exchange rate will decline by 10% over the 3 months period. In order to protect the yen payments, the importer proposes to take appropriate action in the foreign exchange market. The 3 months forward rate is presently quoted as 1.68 yen per rupee. You are required to (i) Calculate the Expected Gain/(Loss) under present situation. (ii) Calculate the Expected Gain/(Loss) if hedged by forward contract. (iii) Recommend which option from above (i) and (ii) will best for the company. Calculation up to 3 decimal points.
Suggested Answer and Working Notes:
Spot rate of 1against yen = 855 lakhs yen/500 lakhs = 1.71 yen 3 months forward rate of 1against yen = 1.68 yen Anticipated decline in Exchange rate = 10%. Expected spot rate after 3 months = 1.71 yen – 10% of 1.71 = 1.71 yen – 0.171 yen = 1.539 yen per rupee (₹ in lakhs) Present cost of 855 lakhs yen 500.000 Cost after 3 months: 855 lakhs yen/ 1.539 yen 555.556 Expected exchange loss 55.556 If the expected exchange rate risk is hedged by a Forward contract: Present cost 500.000 Cost after 3 months if forward contract is taken 855 lakhs yen/ 1.68 yen 508.929 Expected loss 8.929 Suggestion: If the exchange rate risk is not covered with forward contract, the expected exchange loss is 55.556 lakhs. This could be reduced to 8.929 lakhs if it is covered with Forward contract. Hence, taking forward contract is suggested.
Topics: Foreign Exchange Exposure and Risk Management
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