A US exporter invoices a German buyer €1,000,000 due in 90 days. Between signing and settlement, the euro can move 5% either direction. The treasurer's job is to identify the exposure, price it, and decide whether to hedge.
An exchange rate is the price of one currency in another. Quote conventions matter: $1.10/€ means one euro costs $1.10. If a US firm sells a product for $110 and the rate moves to $1.20/€, the same product now costs only €91.67 abroad. The dollar depreciated against the euro, US exports got cheaper for European buyers, and European imports got more expensive for US buyers. Currency moves silently re-price every cross-border invoice.
KEY: Home currency depreciation helps exporters and hurts importers. Appreciation does the opposite. Always identify which side of the trade your firm is on before forecasting impact.
Five drivers dominate exam questions:
- Interest rate differentials. Higher domestic rates attract capital and tend to appreciate the home currency (interest rate parity).
- Inflation differentials. Higher domestic inflation erodes purchasing power and depreciates the home currency (purchasing power parity).
Common mistakes
- Confusing direct and indirect quotes. $1.10/€ and €0.9091/$ describe the same rate. Compute percent change on the quote convention given, not the reciprocal.
- Calling the same percent move symmetric. A 10% gain in the euro is not a 10% loss in the dollar. Always recompute using reciprocals.
- Treating a forward premium as a profit. A forward priced above spot reflects the interest-rate differential, not free money. The "gain" versus an unfavorable spot is an avoided loss.
Bottom line
- A depreciating home currency makes exports cheaper abroad and imports more expensive at home; an appreciating home currency does the reverse.
- Exchange rates move with interest rate differentials, inflation differentials, balance of payments, political risk, and central bank intervention.
- Percent currency change uses new minus old over old and is not symmetric across reciprocal quotes; compute on the quote convention given, not the reciprocal.
- Transaction exposure is hedged with forwards, futures, currency swaps, and currency options: forwards and futures lock a rate, options preserve upside for a premium, and swaps cover multi-year flows.
Exam shortcut
When the question asks direction of impact from an FX move, ignore the math and ask: did the home currency get cheaper or more expensive? Cheaper home currency helps exporters every time. When choosing between forward and option, anchor on commitment. Committed receivable or payable goes forward; contingent exposure (unsigned bid, conditional deal) goes option. When the prompt names "non-convertible currency," the answer is countertrade.
The full lesson (about 1,668 words, 11 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- 2B6
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