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Managing exchange rate risk

If a firm in the United States is due to receive payment of 1 million Australian dollars in 8 years time. It would like to protect itself against a decline in the value of the Australian dollar but finds its difficult to arrange a forward sale of such a long period.

Is there any other way that it can protect itself?

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Even though hedging mechanisms like forward contracts, options and swaps protect companies from exchange rate risks arising in the short term, they are not the most effective and best option for mitigating the long term exchange rate risks, such as the one described above. In the above scenario, the company is due to receive 1 million Australian dollar in the next 8 years. In this scenario, the firm will be beneficial if the dollar depreciates against the Australian dollar. But the firm is worried if the dollar rebounds and gains strength against the Australian dollar as it will hurt the receipts of the company in USD.

The best measure to protect the firm from such Long-term exposures to foreign currency exchange rate risk can be managed primarily through operational activities. Financial hedging tools are typically insufficient or too expensive to address large and long-term exchange rate shifts. To effectively manage long-term ...

Solution Summary

If a firm in the United States is due to receive payment of 1 million Australian dollars in 8 years time. It would like to protect itself against a decline in the value of the Australian dollar but finds its difficult to arrange a forward sale of such a long period.

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