Question

An importer from the United States who owes a Belgian company 500,000 euros payable in 30 days, anticipates that the United States dollar will depreciate in that period.

What would you recommend doing to the importer?

Buy euros now or wait for the debt due date?

What would happen to the importer's utility if, having followed his advice, the dollar appreciated instead of depreciating as the importer had anticipated?

Answer 1

Let's understand the given information: The US importer has to pay a Belgian company 500,000 euros in 30 days, and if the USD depreciates, he will have to pay more in USD terms to buy the same amount of Euros and meet the requirement.

Recommendation:

If the importer strongly feels that the USD will depreciate, then he can enter into a derivative contract. It could be a forward contract of selling USD for a fixed rate of Euro but then the importer will be obligated to fulfill the contract. However, if the USD doesn't depreciate or in fact appreciates, then hedging through the forward contract might not be beneficial. In case of a forward contract, there wont be any upfront payment at the time of entering the contract so that is a plus point. He can even use options such as a put on USD or a Call on Euro. That way, if his expectations is true, he will exercise the option but he has the option of not exercising if the expectations dont come true. For this right but not an obligation option contract, the importer will have to pay a premium which will be non refundable even if the importer doesn't exercise the option. So each of the derivative alternative has its plus or minus.

If the importer doesn't feel too strongly about his expectation, then he might as well do nothing and let the time tell. This is leaving his position unhedged and at times that is not a bad idea.

If the importer is completely sure about his expectations, then he might as well buy Euros now and wait but even so only time can tell what would be the actual exchange rate.

Impact on Utility:

If the USD appreciates, and the importer had entered into a forward contract, then he will lose out because he could have bought the Euros cheaper in the market at the time of settlement but he will have to fulfill the forward contract at a higher rate.

If the USD appreciates, and the importer had entered into an option contract, then he will not exercise the option and lose out only the premium he had paid at the time of purchasing the option. This will reduce his net gain from the exchange of currency.

If the USD appreciates, and the importer had left the position unhedged, then he will gain from the appreciation while if he had already bought the Euro, He will lose out on the exchange rate difference because he could have bought the Euro now at a lower exchange rate.