Question

Alpha and Omega are U.S. corporations. Alpha has a plant in Hamburg that imports components from the United States, assembles them, and then sells the finished product in Germany. Omega is at the opposite extreme. It also has a plant in Hamburg, but it buys its raw material in Germany and exports its output back to the United States. How is each firm likely to be affected by a fall in the value of the euro? How could each firm hedge itself against exchange risk?

Answer 1

Both Alpha and Omega will be affected differently from falling of the value of euro.

=> Since Alpha exports its end product to Germany, will suffer great loss. Weaking of Euro will lead to losses to export product to Germany while using the dollar as exchange currency.

The import rate of Germany will be reduced due to weakening of the euro, thus affecting the market for the end product of Alpha.

Alpha corporation will be buying components at a higher price because it operates in a region where currency is strong. And it will be making losses since the market for the product is in the region where currency is weak.

=> On the other hand, Omega will be benefitting from the falling value of euro currency since it imports raw material from Germany (where euro is weak), meaning more affordability to buy more raw material, more output with less costing and hence increase in the end products. This will also increase the profit margin.

=> Hedging against exchange risk:

Currency forwards can be effectively used here to make sure that change in the currency does not affect much to corporations such as Alpha and Omega.

Forwards eliminates downside risk and fixes future rate. They are relatively straightforward and easy to organise.