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How to Mitigate Foreign Currency Exchange Risk

You're the CFO of the Overseas Sprocket Company, which imports a great deal of product from Europe and the Far East and is continually faced with exchange rate exposure on unfilled contracts. Harry Byrite, the head of purchasing, has a plan to avoid exchange rate losses. He suggests that the firm borrow enough money from the bank to buy a six- month supply of foreign exchange that would be kept in a safety deposit box until used.

"We'd never have another unexpected exchange rate loss again," says Harry. Prepare a polite response to Harry's idea. Explain why you do or don't like it, and suggest an alternative if you feel one is appropriate.

Solution Summary

This solution discusses (with references) the alternatives to buying currency at a spot rate and holding it until bills are due. It discusses and differentiates several derivative instruments in plain English.

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