Your start-up company has negotiated a contract to provide a database installation for a manufacturing company in Poland. That firm has agreed to pay you 100,000 CAD in three-month’s time….
Your chief financial officer (CFO) was unable to attend the recent monthly chamber of commerce meeting.
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.