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In: Operations Management

Dealeo Foods Inc. purchases vitamins from a supplier abroad. The invoices received by Dealeo are denominated...

Dealeo Foods Inc. purchases vitamins from a supplier abroad. The invoices received by Dealeo are denominated in the foreign currency. Dealeo understands that fluctuations in foreign currency exchange rates may adversely affect the company’s earnings. The CFO of Dealeo wants you to investigate derivative instruments and determine whether or not the use of a foreign currency forward contract or foreign currency options is best to hedge the company’s exposure to foreign currency exchange risk.

REQUIRED:

Suppose you chosed any country other than the US...

1. Draft a memo to explain to the CFO the advantages and disadvantages of using a foreign currency forward contract and foreign currency options for hedging. Based on the history of the exchange rates, how might these options impact Dealeo?

2. Make a recommendation on the hedging instrument that you believe the company should use. Justify/support your recommendation.

NOTE: Please cite any sources used, FASB Codification and any other sources.

Solutions

Expert Solution

To: CFO, Dealeo

From: Hen Scott

Date: March 18, 2018

Subject: Considerations for hedging

Dear Mac,

As you know, we have been dealing with the invoices of suppliers denominated in foreign currency. That gets administered to the foreign exchange rate fluctuations and can be heavy on the company’s expenditures. I would like to divert your attention to the implementation of currency options for hedging.

Currency option offers the flexibility to the buyer to exchange a particular quantity of a currency for a pre-agreed quantity of another currency at a stipulated date and time.

The advantages of using currency option are:

  • Very cheap to trade
  • Can be availed through exchange
  • Risk exposure is very low for buyer
  • High potential of returns
  • Price movement and volatility can be estimated and strategized

The disadvantages of using currency option are:

  • Risk exposure is high for seller
  • Shelf-life is limited
  • Can become illiquid

So, we can infer that using currency options can be beneficial for our business. Let’s meet to discuss the strategic plan for the implementation of currency options in the business.

Sincerely,

Hen Scott

https://www.berryfx.com/advantages-disadvantages-forward-contracts-currency-options/

https://www.investopedia.com/exam-guide/cfp/characteristics/cfp30.asp

keosha answered 7 months ago
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