Question

You are the manager of a company that operates internationally providing agricultural equipment that has been manufactured and assembled in Canada. You have sold your products in the United States for many years and are now looking to enter other markets.
Your company has decided to enter the Argentinean market. You have decided to use a wholesaler, who will distribute it to the retail market. The potential size of the market is $10,000,000 USD per year. However, your wholesaler will not assume the risk of invoices charging USD and they want at least 60 days before paying. They argue that they will have to give their retailers 60 days to pay and their retailers will only pay them in pesos. Argentina has just come out of a currency crisis and your Canadian bank has warned you of possible severe currency fluctuations. What payment and currency strategy will you suggest to your senior management? Explain your answer (no calculations involved).                                                     

Answer 1

In order to avoid the risk of currency fluctuation, the best strategy would be to provide the wholesaler with a credit as demanded but at the same time insist for a USD denominated payment and not in the local Argentine currency. In case this is not acceptable to the wholesaler, then a good strategy could be to use forward contracts or future& options to hedge the currency risk.

1) Forwards - Using currency forwards purchased from the bank, the firm can hedge its future receivables and lockin the amount of the money that it would receive in the future. For this facility the firm would need to pay a small premium to the bank.

2) Futures & options - Another option would be to purchase currency futures or options that are traded in the exchange and take a position that protects against the potential devaluation of the Argentine currency.

3) Natural hedge - Last option is to start sourcing some raw materials from Argentina and this would also provide a natural hedge through decrease in cost of raw materials if Argentine currency devaluation occurs.