Question

A Question on Foreign Exchange Risk Collapse As the CFO of a multinational company, which financial securities can you use to manage the foreign exchange risk that your company faces? How do they work? Hint: Think about financial derivatives!

Answer 1

If a company is engaged in the business of selling goods and services to a different country either in the form of exports or in the form of direct selling, the company has to face issues of foreign exchange. For example, If Coca Cola sells 1000 bottles of cola in India at Rupees 70 per bottle, it equals to 70,000 rupees or $1,000. However, while the payment is received to company, the exchange rate may go up at 72, this would mean that company will be able to convert 70,000 rupees into $972 only and hence there is a loss of $28 on such sale. One of the most prominent ways that CFO's of various multinational companies have chosen to manage that risk is use of financial securities like financial derivatives. Financial derivatives is an instrument in which the company will buy or sell the futures of currency in which they operate with an aim to make sure that any loss due to currency fluctuation in direct business is set off by the gains through financial derivatives. There are various financial derivative options like buying or selling of calls and put options, buying or selling of currency futures directly etc.