Question

You are a handicraft dealer in Australia and import materials from New Zealand. You have accounts payable to your suppliers from New Zealand in New Zealand Dollars.
1.)a.) Explain the exposure risk your company will face if you do not hedge transactions?

b.) If you hedge, which hedging method would you use? State you reason why?

Answer 1

a) The handicraft dealer from Australia is exposed to transaction exposure risk which is the risk related to day to day fluctuations in exchange rates. So, in this case if the New Zealand dollar becomes stronger then handicraft dealer has to pay more for his imports if he does not hedge his transactions.

b) This risk can be hedged by entering in forwards and futures contract in which we can fix the future exchange rate of imports today which would thus help in hedging the risk against the unfavourable movements in exchange rates.