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In: Finance

Springfield Co., based in the U.S., has customers in London, England that uses the British Pound...

Springfield Co., based in the U.S., has customers in London, England that uses the British Pound Sterling as its currency. Name and discuss the technique that the firm can use to determine whether the quarterly percentage change in its total cash flow is related to the quarterly percentage change in the British Pound Sterling's value.

Solutions

Expert Solution

Springfield Co., is based in U.S. and their customers are in London,England, who pays in British pound for purchase from Springfield Co.

Therefore Springfield is exposed to foreign exchange risk as it will receive British pounds for its products and need to convert it to US dollar.

This type of exposure is transaction exposure.

Transaction Exposure

It is the level of risk for firms involved in international trade .

Fluctuating exchange rates can lead to major losses for firms. Often when a firm identifies exposure to changing exchange rates it will choose to implement hedging strategy using forward contacts so that they can lock exchange rates and eliminate the exposure to risk.

Example

Suppose that Springfield Co. Sells products to customers in London . It will need to translate British pound to US dollars.

However, between the time of sale and settlement of payment the GBP/USD exchange rate may change and can cause huge losses to cash inflows to Springfield Co.

If the currency pair fall the company will receive less U.S. dollar from the sale as the value of GBP falls.

jeff jeffy answered 2 years ago
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