An American manufacturer with its corporate headquarters in New York City is purchasing goods from a French supplier. Which of the following statements is true regarding the exchange rate risk for this contract?

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BlackTom AI · Accepted Answer

Examining the exchange rate risk question requires evaluating how currency denomination affects who bears risk in a cross-border contract.
Option a: 'The American company will bear all of the exchange rate risk if the contract is denominated in dollars.' This is misleading because even when a contract is denominated in a single currency (e.g., dollars), exchange rate risk can still arise for the party that is not invoicing in its own functional currency, or if payment timing and currency conversion introduce exposure. In practice, risk is not automatically borne solely by the buyer just because dollars are used; other factors such as payment terms, invoicing currency, and where costs are incurred can shift risk.
Option b: 'The French company will bear all of the exchange rate risk if the contract is denominated in dollars.' This statement is plausible in some setups: if the invoice is in dollars and the French seller must convert proceeds to euros, the seller could bear the conversion risk. However, this depends on contract terms like who quotes, who bears conversion costs, and whether the contract specifies currency hedges or default settlement in a way that transfers risk.
Option c: 'Both companies could bear exchange rate risk if the contract is denominated in British pounds.' If the contract uses a currency different from both parties' home currencies (here, pounds), both sides face potential exposure depending on where each party earns revenue and incurs costs. Even when one party’s costs or revenues are in dollars, currency movements against pounds could create risk for both sides if both are indirectly exposed or if payment settlement involves conversions.
Option d: 'Both b and c are correct' claims that in scenarios described by options b and c, both parties could bear exchange rate risk depending on the currency denomination and contract specifics. This recognizes that risk is not rigidly assigned by who pays and who sells; it can be shared or shifted based on contract terms, invoicing currency, and hedging arrangements.
Putting these together, the core concept is that exchange rate risk is influenced by the currency in which the contract is denominated and by how payments are settled, invoiced, and converted, which can place risk on different parties in different scenarios. Misconceptions in option a overemphasize a fixed risk allocation when real-world contracts often involve nuanced terms. Option b’s framing is situationally plausible but incomplete without contract details, and option c correctly notes that using a third currency (pounds) can expose both sides depending on their respective currencies of operation and settlement.
Overall, recognizing that risk can be borne by either party depending on denomination, terms, and settlement clarifies why the combined statement in option d is the most comprehensive choice.

MCD2170 - T3 - 2025 Week 8 post class homework

An American manufacturer with its corporate headquarters in New York City is purchasing goods from a French supplier. Which of the following statements is true regarding the exchange rate risk for this contract?

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