Question

You are the CFO of a U.S. firm whose wholly owned subsidiary in Mexico manufactures component parts for your U.S. assembly operations. The subsidiary has been financed by bank borrowings in the United States. One of your analysts told you that the Mexican peso is expected to depreciate by 30 percent against the dollar on the foreign exchange markets over the next year. What actions, if any, should you take?

Answer 1

Subsidiary in mexico has borrowings in dollar, means it will have to make interest payment in dollar. If mexican peso depreciates by 30% against US dollar than more unit of mexico peso will be needed to buy one unit of US dollar and thus there will be more outflow of mexican peso.

To mitigate this risk one can buy forward contract on US Dollar or can buy call option on US dollar ( This will give right to company to buy dollar at pre determined rates) thus protecting oneself from appreciation of US Dollar