Palmetto Bug Extermination Corporation (PBEC), a U.S. company, regularly purchases chemicals from a supplier in Switzerland with the invoice price denominated in Swiss francs. PBEC has experienced several foreign exchange losses in the past year due to increases in the U.S. dollar price of the Swiss currency. As a result, Dewey Nukem, PBEC’s CEO, has asked you to investigate the possibility of using derivative financial instruments, specifically foreign currency forward contracts and foreign currency options, to hedge the company’s exposure to foreign exchange risk.
Required
Draft a memo to CEO Nukem comparing the advantages and disadvantages of using forward contracts and options to hedge foreign exchange risk. Recommend the type of hedging instrument you believe the company should employ and justify this recommendation.
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