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How to Mitigate Foreign Currency Exchange Risk

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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.

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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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