You learned from some other local CFOs that changing exchange rates had dramatically affected their firms’ profitability. You spoke to 3 different CFOs, and each planned in the future to use a different form of reducing foreign exchange rate risk. Upon your return to the office, the CFO of your company asked you to transcribe what you learned into a memo that he and others in the finance department could all understand.
In your memo, make sure to address the following topics:
- What exactly is meant by exchange rate risk?
- Give a simple, numerical example of this.
- Do both parties in an international trade transaction incur this same risk? Explain.
- Describe and provide a numerical example of the forward exchange contract as a method to reduce the exchange rate risk using the following data:
- The ABC company has purchased goods (worth 1,000,000 yuan) from a Chinese firm at a time when the spot exchange rate happens to be $1 to 6.667 yuan.
- The ABC firm’s CFO thinks that in 180 days, the spot rate could be as high as $1 to 6.2 yuan.
