ACCA Financial Management (F9) Certification Practice Exam

What is the first step in a money market hedge for a foreign currency payment?

1. Convert home currency to foreign currency

2. Deposit the foreign currency immediately

3. Borrow the appropriate home currency

4. Repay the loan in home currency

The correct answer is: Borrow the appropriate home currency

In a money market hedge for a foreign currency payment, the first step is to borrow the appropriate amount in the domestic currency. This initial borrowing is essential as it allows the company to obtain the funds needed to cover the future foreign currency payment. Once the domestic currency is borrowed, it is then converted into the foreign currency at the current spot exchange rate. This step locks in the exchange rate and secures the necessary funds for the future payment. After securing the foreign currency, that amount is typically deposited in a foreign currency account or used directly for payment. The borrowing in the domestic currency enables the business to hedge against fluctuations in exchange rates, ensuring that the cost of the payable remains stable over time. Repaying the loan in home currency occurs at the end of the transaction, utilizing the funds that have already been secured by converting to foreign currency. It's critical to follow this sequence to effectively minimize the risk associated with currency exchange fluctuations.