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In: Finance

What kind of hedging needs a US exporter might have and what their other alternative options...

What kind of hedging needs a US exporter might have and what their other alternative options are?

Solutions

Expert Solution

A US exporter would get into 2 kinds of hedging:-

1) Commodity/Product Hedge

2) Currency/FX Hedge

Commodity Hedge - There are price fluctuations of commodities on a daily basis. To mitigate the risk of selling his product at an unfavorable cost in the future, the exporter would hedge this volatility by selling commodity futures. This would assure the exporter of any downside in the price of the commodities. If there is a fall in price, the loss in the cash market position will be countered by a again in the futures market. An alternative way to hedge this risk is getting into a forward agreement which can be easily customized according to the needs but the counterparty risk increases.

Currency Hedge - The US exporter has hedged his selling price of the product, now he will receive the sales amount from the counterparty in foreign currency for which he has to hedge the currency too. This is done in order to protect the exporter from any unfavorable currency fluctuation. For example, if the EUR/USD is currently trading at 1.13 and at the time of receipt the USD gets stronger to 1.10. In this case the exporter would have to incur a loss as his receivables in Euros would now be converted into USD at a lower exchange rate of 1.10 which means lower net receivables in USD. To avoid such cases and avoid currency fluctuation affect his cash inflows, the exporter would get into a sell currency futures. So no matter what the rate is in future, the exporter has locked the rate at which the Euros would be converted. An alternative way to hedge currency risk is to buy/sell currency forwards which again can be easily customized and no margins need to be posted.


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