Question

Multinational corporations are faced with continuous exposure to exchange rate risk. Each company must decide how best to manage that risk. Find an article on how another multinational corporation chose to deal with its exchange rate risk.

Prompt: First, briefly summarize the strategy and/or tactics the company in your article used to manage its currency risks

minimum 250 words

Answer 1

EXCHANGE RATE RISK-it is defined as the variance in the domestic value of assets, income due to change in the exchange rate. example if a person imports some machine and its price is $1lakh after converting it into domestic currency (in rupee) exchange rate is $1= Rs.75 so a person has to pay Rs. 75 lakh for that machine. now if dollar loosens its value i.e $1= Rs.70 you have to pay Rs. 70 lakh for that machine, and if the dollar strengthens i.e $1= Rs.78 person has to pay Rs.78 lakh for that machine. so this is the concept of exchange rate risk. currency risk occurs due to three types-

• translation exposure- as we have to convert assets and income in the home currency.
• transaction exposure- fluctuation in currency either currency strengthen or loosen
• economic exposure- the overall impact of exchange rate changes on the value of firms.

HOW we manage exchange rate risk- by HEDGING technique, there are lots of hedging techniques used to manage currency risk-

Derivatives- the derivative transaction is a payment exchange agreement whose value depends on the value of underlying assets, reference rate etc. Two fundamental blocks used-

Forward - based derivatives( both seller and buyer obligated to perform)

• the forward contract( tailormade) the buyer of the contract draws its value at maturity from its cash settlement. it draws on discount(currency is cheaper in future value date) and premium(when a currency is costlier for a future date)
• swap(infinitely flexible) - method of exchanging the underlying economic basis of a debt or assets without effecting underlying conditions. classified as a currency, interest rates, commodity
• future contract(standardized)- standardized contract to buy and sell in future at today agreed price, it could be commodities, stock, bond. conditions related to quantity time and delivery.   

Option-based derivatives(the only seller obligated to perform)- it gives the buyer the right, not the obligation to buy or sell underlying assets at a certain price either on or before a specific date.

• call option- a contract that gives the buyer the right not obligation to buy many units at a fixed price upon specific date
• put option- a contract that gives the buyer the right, not the obligation to sell a specified number of a commodity at a fixed price upon the specific date.

EXAMPLE- investor buys a call option to buy 100 ITC share for Rs. 300 on a specific date. current price is Rs 250 and the premium for the option is Rs 25

the maximum loss of investor= 25*100=2500( initial investment)

he is entitled to get a share at a price of Rs300

if the market price of ITC goes up to Rs400, the investor will exercise his right by paying Rs. 30000(300*100)