Question

Mexichem, a Mexican company specializing in certain piping, vinyl, and other chemical products, exports 70% of its $5.7 billion in annual sales: 30% to the U.S. and 20% each to Japan and Europe. Assume it incurs all its costs in Mexican pesos, while most of its export sales are priced in the local currency.

Can Mexichem eliminate its operating exposure by hedging its position every time it makes a foreign sale or by pricing all foreign sales in pesos? Why or why not?

Answer 1

To hedge the operting exposure, firm is thinking of two alternatives -

1. By hedging its position every time it makes a foreign sale.

Well, this method can be tried but it is costlier one. For evey foreign sales, using financial derivatives to hedge its exposure would incur large cost to company. Second, it is also not possible that for every sales, suitable derivatives of same value are available. Thus, a partical hedge will not give the desired result.

2. Pricing all foreign sales in peso.

Yes, it is the most perfect way to hedge the operating exposure. But, this method has also some limitations. First, for a particular peso price of goods, the price of same goods in foreign currency will have to change frequently due to exchange rate movement. This is a cumbersome process and may affect the demand of goods in foreign country. Second, company may lose the benefit arising due to favorable exchange rate movement.

Therefore, both the alternatives are not perfect, however, if one has to be selected then ompany should go for second alternative i.e. goods should be priced in Peso.