You are the chief financial officer (CFO) of a company that has recently entered the global marketplace. You have been meeting with the marketing and sales managers of the firm, and you are trying to adopt strategies that will minimize foreign exchange risk.
The sales and marketing managers are weighing the pros and cons of selling to customers in Mexico versus selling to customers in England. Because the sales and marketing managers are about to enter negotiations with large customers in both countries, you want to prepare them with important background information.
- Go to http://www.xe.com/ to determine the current exchange rate of U.S. dollars to Mexican pesos, and U.S. dollars to British pounds. Make sure to cite the source of data and the date on which you found it because exchange rates are always shifting.
- Without hedging currency, answer the following questions:
- What would happen to profits if you sold 1,000 widgets to each country (at today’s exchange rate) at a price of either 1 pound each (if sold to England) or 25 pesos (if sold in Mexico)?
- If the dollar weakened by 10% relative to each country’s currency, what would be the new exchange rate used for this calculation?
- What would happen to profits if you did hedging by buying forward contracts in foreign currency (at today’s exchange rate) at a cost of $50, and after the purchase, the U.S. dollar depreciated by 10%?
From the exchange rate data determined, complete the following requirements:
- Explain the pros and cons of hedging strategies
- Explain what would have happened to profits or potential profits if the dollar had strengthened, rather than weakened (in Part I) and if the same forward contracts had been purchased for $50.
- From the information obtained, give specific factors that you feel must be considered before buying futures contracts for currency.
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