Question

Each month, the Sports Exports Company (a U.S. firm) receives an order for footballs from a...

Each month, the Sports Exports Company (a U.S. firm) receives an order for footballs from a British sporting goods distributor. The monthly payment for the footballs is denominated in British pounds, as requested by the British distributor. Jim Logan, owner of the Sports Exports Company, must convert the pounds received into dollars.

1. Explain how the Sports Exports Company could utilize the spot market to facilitate the exchange of currencies. Be specific.

2. Explain how the Sports Exports Company is exposed to exchange rate risk and how it could use the forward market to hedge this risk.

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Answer #1

1. Sports company can use the spot exchange market to convert their pounds payment into dollars. Company can go to any bank to convert pounds into dollars as per the current spot exchange rate between pounds and dollars.

2. Exchange rate risk that dollar might be depreciated at the time of payment received. It means when he goes to convert pounds into dollars in spot market , he will get less dollars against the pounds due to depreciation of dollar.

Company can use forward market to hedge any exchange rate risk. In that market , company can fix the exchange rate between pounds and dollars and later when it converts , company is ineffective of spot exchange rate at that time .

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