ACCA Financial Management (F9) Certification Practice Exam

Which task is typically involved in a money market hedge for a foreign currency payment?

1. Converting the foreign currency to the home currency

2. Putting the foreign currency on deposit

3. Buying a forward exchange contract

4. Repaying the loan in foreign currency

The correct answer is: Putting the foreign currency on deposit

In the context of managing foreign currency risk, a money market hedge involves the use of the domestic and foreign money markets. For a foreign currency payment, the typical task is to put the foreign currency on deposit. By depositing the foreign currency, the company can effectively create an obligation to pay the foreign amount owed, while also earning interest on that deposit. This approach essentially locks in the exchange rate through the use of interest rate differentials between the domestic and foreign currencies. For example, if a company knows it will need to make a payment in a foreign currency at a future date, it can borrow the equivalent amount in its local currency, convert it to the foreign currency, and then deposit that amount in a foreign bank account. This setup guarantees the amount needed for the future payment, thus hedging against fluctuations in the exchange rate that may occur before the payment is due. The other tasks mentioned do not directly involve creating a money market hedge for a foreign currency payment. Converting the foreign currency to the home currency or buying a forward exchange contract both involve different mechanisms for hedging currency risk, while repaying a loan in foreign currency is a separate activity that does not constitute a money market hedge. Therefore, placing the foreign currency on deposit is the