With three of these five combinatio

With three of these five combinations—II, PP, and EE—the same exchange rate is used for translating both budget figures and performance figures into the corporate currency. All three combinations have the advantage that a change in the exchange rate during the year does not distort the control process. This is not true for the other two combinations, IE and PE. In those cases, exchange rate changes can introduce distortions. The potential for distortion is greater with IE; the ending spot exchange rate used to evaluate performance against the budget may be quite different from the initial spot exchange rate used to translate the budget. The distortion is less serious in the case of PE because the projected exchange rate takes into account future exchange rate movements.Of the five combinations, Lessard and Lorange recommend that firms use the projected spot exchange rate to translate both the budget and performance figures into the corporate currency, combination PP. The projected rate in such cases will typically be the forward exchange rate as determined by the foreign exchange market (see Chapter 10 for the definition of forward rate) or some company-generated forecast of future spot rates, which Lessard and Lorange refer to as the
internal forward rate
. The internal forward rate may differ from the forward rate quoted by the foreign exchange market if the firm wishes to bias its business in favor of, or against, the particular foreign currency.