Question

You agree to sell merchandise to a French customer and will receive payments in euros 6 months from now. The current value of the transaction is 10 million euros. The exchange rate is 1 euro= 0.83 dollars

1. What specific risk do you face with such a transaction? Explain with example.

2. How can you protect yourself from risk you described?

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3. List and explain 4 factors that determine business risk

Answer 1

1) The first risk that a person faces is default risk. The French customer may not pay up due to any reason.
The most common risk in such transactions is currency exchange risk. The value of dollar can appreciate relative to Euro in the coming 6 months. This shall reduce the dollar inflow to the US company. For example if the dollar appreciates and the rate rises to 0.85 dollars per euro. Initially the company would have received = 10/0.83=$12.05 million dollars. But since now the rates have risen the company shall only receive =10/0.85=$11.76 million

2) One can protect oneself from the risk by hedging the rate. One can enter a 6 month forward and can be sure of inflow that could be received.

3) The 4 factors that determine business risk are:

• Variability In Demand- The demand of the product of the company produces changes and if the company can adapt to change it shall be better
• Variability In Selling Price- To what extent company can change the price of the product.
• Uncertainty Of Input Costs. ...
• Ability To Price Adjustment. ...
• Speed Of Technological Changes. ...
• Extent Of Fixed Operating Costs