Question

Parco, Inc., a U.S. entity, has a 100% owned subsidiary, Subco, Inc., located in the country of Eastlaco. In which one of the following arrangements would there be no foreign currency exchange risk associated with borrowing by either Parco or its subsidiary, Subco, prior to consolidation?

A. Parco borrows in the currency of Eastlaco.
B. Subco borrows in the U.S. dollar.
C. Subco borrows in the currency of Eastlaco.
D. Parco borrows in the currency of a third country.

Answer 1

Answer: C. Subco borrows in the currency of Eastlaco.

Step-by-step explanation:

Exchange rate risk only occurs when an entity borrows in a currency that is not their own. This means that if the currency they borrowed in was to appreciate against theirs, they would have to pay more than usual.

Subco is located in Eastlaco so if they borrowed funds in the currency of Eastlaco they would not have to worry about exchange rate risk because they are paying back in their local currency which cannot appreciate or depreciate against itself.