Question

You’re the treasure of warm wear Inc. which imports wool sweaters from around the world. Kreploc, a company in the country of Slobodia, has a product your marketing department would like to carry and doesn’t require payment until 90 days after delivery. Unfortunately, the Slobodia blivit tends to vary in value by as much as 30% over period as short as three months. This makes me reluctant to do business with kreploc because of the exchange rate risk. The marketing department can’t understand why you have any concerns at all. Prepare a brief explanation, including illustration, of why you’re concerned.

Answer 1

We are importer means we have to make payment in foreign currency after 90 days. It means we have to buy foreign curreny and sell out home currency. Now if Foreign currency fluctuates as much as 30% then there are chances that foreign currency might appreciate against our home currency. in such situation we will have to pay more units of home currency to buy one unit of foreign currency than what we had budgeted. thus the cost of manufacturing will increase reducing competitive edge of the company.
In order to mitigate this risk one can buy future contract on Foreign currency or sell forward contract on home currency.