Question

A shoe factory in China produces shoes for Nike. Its costs are in CNY, and revenue in USD. Does the owner worries about USD depreciating or appreciating against CNY? How should the owner use exchange rate futures to hedge?

Answer 1

• If costs are in CNY and the revenue in USD, if the USD depreciates against CNY, it would worry the manufacturer because for every dollar of revenue, he would be able to convert it into lower number of CNY to cover his cost.
• He can hedge this risk by entering into forward contract or a Swap which is a series of forward contracts, where he can sell the USD to receive a certain predetermined number of CNY in exchange. This would reduce his risk if the USD depreciates. But also it would reduce the profit if USD appreciates because forward contract has to be fulfilled.
• He may also buy a put option on USD which gives him the option of selling the USD at a predetermined rate but not an obligation to do so because if USD appreciates, he would not want to lose his profits. For buying this option, he will have to pay an upfront premium and if the option is not exercised, that is not refunded. So this is a loss but between forward or swap and option, there is this tradeoff, which he will have to bear.