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Foreign exchange risk

Question 2

Economic risk

A US exporter sells one product in the UK on a cost plus basis and invoices in £
to remain competitive in the UK market. The selling price in £ is based on costs
of $125 plus a mark-up of 5% to give a sales price of $131.25.

The current exchange rate is £0.81 = $1

Does the exporter still make a profit on the goods if the exchange rate moves to
£0.87 = $1?

Current invoice price: $131.25 × £0.81 = £106.31

If exchange rate moves, £106.31 will be received and then converted into US$
at the new rate.

At the new rate, this would give £106.31/0.87 = $122.20.

With costs of $125, the exporter is no longer able to make a profit at the same
sales price.

Illustrations and further practice

Now try TYU question 2 from Chapter 13.

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