Question

1. Which financial strategy would you choose to mitigate risk exposure?
2. In your own words, present an example using XYZ company.

Answer 1

Risk Mitigation

Risk mitigation can be defined as taking steps to reduce adverse effects. There are four types of risk mitigation strategies that hold unique to Business Continuity and Disaster Recovery. When mitigating risk, it’s important to develop a strategy that closely relates to and matches your company’s profile.

Use Forward Contracts

Currency forward contracts are another option to mitigate currency risk. A forward contract is an agreement between two parties to buy or sell a specific asset on a particular future date, at one particular price. These contracts can be used for speculation or hedging.

Currency forward contracts are another option to mitigate currency risk. A forward contract is an agreement between two parties to buy or sell a specific asset on a particular future date, at one particular price. These contracts can be used for speculation or hedging. For hedging purposes, they enable an investor to lock in a specific currency exchange rate. Typically, these contracts require a deposit amount with the currency broker. The following is a brief example of how these contracts work.

Let's assume one U.S. dollar equaled 111.97 Japanese yen. XYZ COMPANY is invested in Japanese assets, has exposure to the yen and plans on converting that yen back to U.S. dollars in six months, XYZ COMPANY can enter into a six-month forward contract. Imagine that the broker gives the investor a quote to buy U.S. dollars and sell Japanese yen at a rate of 112, roughly equivalent to the current rate. Six months from now, two scenarios are possible: The exchange rate can be more favorable for the investor, or it can be worse. Suppose the exchange rate is worse, at 125. It now takes more yen to buy 1 dollar, but the investor would be locked into the 112 rate and would exchange the predetermined amount of yen into dollars at that rate, benefiting from the contract. However, if the rate had become more favorable, such as 105, the XYZ COMPANY would not get this extra benefit because he would be forced to conduct the transaction at 112.