Question

Suppose that Boeing (US company) sold airplane to Lufthansa (German company) on credit and invoiced €20 million payable in six months. Two companies agree to share the currency risks. In the Price Adjustment Clause, the neutral zone is $1.14/€ - $1.26/€, the base rate is $1.2/€; and both parties will share the currency risk beyond a neutral zone. How much each party have to pay/receive if:

How much each party have to pay/receive if the exchange rate is $1.08/€

a. Boeing receives $21.6 million; Lufthansa pays €20 million.

b. Boeing receives $23.4 million; Lufthansa pays €21.67 million.

c. Boeing receives $24 million; Lufthansa pays €20 million.

d. Boeing receives $22.2 million; Lufthansa pays €20.56 million.

Answer 1

The correct answer is option (b) Boeing receives $23.4 million; Lufthansa pays €21.67 million.

Base rate = $1.2/€

Prevailing rate = $1.08/€

Differential = 1.20 - 1.08 = $0.12/€

Hence each part's share = Differential / 2 = 0.12 / 2 = $0.06/€

Effective exchange rate for Boeing = 1.08 + 0.06 = $1.14/€

Hence adjusted payment by Lufthansa = €20 mn / 1.08 x 1.14 = € 21.67 and the payment received by Boeing = € 21.67 x 1.08 = $ 23.40

Hence, the correct answer is option (b) Boeing receives $23.4 million; Lufthansa pays €21.67 million.