Question

Our firm, Greedy Gecko's Garments (GCKO), buys special spray bottles for its Remarkable Stain Repellent from a supplier in Canada. GCKO sells its final product in the U.S. only. In 6 months, GCKO is contracted to pay 2 million Canadian dollars (CAD) to its Canadian supplier. Another U.S. firm sells a competing product, but all of its components are purchased in the U.S. (i.e., all denominated in U.S. dollars).

In the space provided, answer BOTH of the following questions:

1) Briefly explain the risk that GCKO has relative to its U.S. competitor.

2) Identify ONE (and only one) method the firm could consider to manage this risk that does NOT involve a hedging contract (e.g., forwards, futures, options).

Answer 1

1)

As it is mentioned the Greedy Gecko's Garments buys spray from Canada while its competitors buy the spray from the US only.

Hence,

The risk involved with GCKO is exchange rate risk. He has to pay the money in CAD after 6-months. Therefore the amount of payment is uncertain. He has to pay the USD based on the exchange rate on the date of payment. And if CAD appreciates in 6 months than he has to pay a higher amount than expected.

2)

The way to mitigate this risk apart from hedging is by buying the 2 million CAD now. ( He could buy a lower amount if he has the ability to generate a fixed return for 6 months)

If he doesn't have money now. Then he should take a loan to buy the currency. This loan will make it almost certain that how much amount he has to pay. And the exchange rate risk will be completely wiped out.