Question

Describe the risks and uncertainty a U.S. company faces when purchasing inventory from a foreign corporation and settling the transaction in the foreign currency. How could the risk be minimized? Short answer

Answer 1

Foreign exchange risk is a financial risk that exists when a financial transaction is denominated in a currency other than that of the base currency of the company. The exchange risk arises when there is a risk of appreciation of the base currency in relation to the denominated currency or depreciation of the denominated currency in relation to the base currency.

In Present Case,U.S. company faces when purchasing inventory from a foreign corporation and settling the transaction in a foreign currency. If value of US dollar decrease then he want to pay extra to supplier. It increase the risk to US Company. US company has a transaction risk when settling the transaction in foreign currency.

There is transaction risk to U.S. Company and there is uncertainty whether value of US Dollar is decreased or not in comparison of foreign currency

Through following way risk can be minimized:-

Through Future contract risk can be minimized , a futures contract (more colloquially, futures) is a standardized forward contract, a legal agreement to buy or sell something at a predetermined price at a specified time in the future, between parties not known to each other.

Another way is call option, Call options are agreements that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity or other instrument at a specified price within a specific time period. Through call option U.S. Company can remove the risk of foreign exchange fluctuation , This help to remove all uncertainty related to when purchasing inventory from a foreign corporation and settling the transaction in a foreign currency.