At the next finance department staff meeting, the CFO asked you to lead a discussion on the use of one specific tool to reduce exchange rate risk?a currency swap (The others are forward contracts and futures contracts.). He asked you to cover the following questions:
-What would be a typical example where your company engaged in international business and, interested in selling long-term bonds, might make use of currency swaps? The proceeds from the bond sale will be used to expand a factory, in the home country, which is country A.
-Are there any disadvantages to using a currency swap? How could you minimize the impact of these disadvantages?
So, there are numerous possible examples of this scenario occurring in real life. Consider a company like Caterpillar, which operates in dozens of countries around the world. We will assume Caterpillar is based in the United States. If Caterpillar issued debt in a foreign country, with the intention of developing a factory in the United States (the example above) it would face considerable exchange rate risk as it held the foreign currency. If the foreign currency depreciated against the USD while holding those foreign funds, Caterpillar could take considerable losses. This example is not ...
The specific tools to reduce exchange rate risks are determined.