The correct answer is C: “Avoid both transaction cost and exchange risk.”

Maintaining a foreign currency account can indeed help in avoiding both transaction costs and exchange risk, and here’s a detailed explanation of why this answer is correct:

Avoiding Transaction Cost:

When individuals or businesses engage in international transactions, they often have to convert their domestic currency into the foreign currency of the transaction. This conversion typically involves transaction costs, which can include fees and commissions charged by banks or currency exchange services. These costs can add up, especially for frequent international transactions.

By maintaining a foreign currency account, you essentially hold funds in the foreign currency itself. This means that you don’t need to convert your money each time you engage in an international transaction.

Since the funds are already in the foreign currency, you can make payments directly in that currency without incurring additional conversion fees or transaction costs. This can result in significant savings, particularly for those who conduct a high volume of international business or travel frequently.

Avoiding Exchange Risk:

Exchange rate risk, also known as currency risk or exchange risk, is the potential for the value of your domestic currency to fluctuate against the foreign currency you need for a transaction. These fluctuations can either lead to favorable or unfavorable exchange rates, impacting the final cost of your international transactions.

Maintaining a foreign currency account helps mitigate this risk. When you have funds in the foreign currency, you are protected from adverse exchange rate movements. You have a fixed amount in that currency, so you know exactly how much it’s worth in that foreign currency, regardless of how exchange rates fluctuate.

For example, if you need to pay a foreign supplier a set amount in U.S. dollars, and you hold a U.S. dollar account, you won’t be affected by fluctuations in the exchange rate between your domestic currency and the U.S. dollar. This stability can provide financial predictability and reduce the uncertainty associated with international transactions.

Now, let’s discuss why the other options are not correct:

Option A: Avoid Transaction Cost:

This option is not entirely accurate. While maintaining a foreign currency account can help avoid some transaction costs related to currency conversion, it does not eliminate all transaction costs associated with international transactions.

There may still be fees or charges for certain types of transactions, such as wire transfer fees or intermediary bank charges. Additionally, there could be costs associated with opening and maintaining the foreign currency account itself, including account maintenance fees.

Option B: Avoid Exchange Risk:

Option B is partially accurate but incomplete. Maintaining a foreign currency account does help avoid exchange risk related to currency fluctuations for funds held in that account.

However, it does not protect you from exchange risk for transactions involving different currencies. If you need to convert funds between different foreign currencies, you are still exposed to exchange rate fluctuations unless you hold accounts in all the relevant currencies.

Option D: Avoid Exchange Risk and Domestic Currency Depreciation:

This option is not entirely correct because while maintaining a foreign currency account can indeed help avoid exchange risk, it does not directly protect against domestic currency depreciation. Domestic currency depreciation is a separate economic phenomenon influenced by various factors, including inflation rates, interest rates, and economic stability.

The value of your domestic currency relative to foreign currencies can still decrease even if you have funds in a foreign currency account. However, holding foreign currency can serve as a hedge against domestic currency depreciation to some extent, as you have assets in a more stable foreign currency.

In conclusion, maintaining a foreign currency account is a useful financial strategy that can help individuals and businesses avoid both transaction costs and exchange risk when dealing with specific foreign currencies. It provides a convenient way to hold, manage, and transact in foreign currencies directly, without the need for frequent conversions.

However, it’s important to consider the associated costs and fees when opening and maintaining such accounts and to be aware that it may not fully protect against domestic currency depreciation, which is influenced by broader economic factors.