Assignment
Volatility in the foreign exchange markets greatly impacts corporate investment decisions. You are examining the factors that determine exchange rates and the ways in which exchange rates impact profitability.
To prepare for this Assignment, keep this week's readings in mind. Then, read the two related scenarios (1 and 2) below, and begin formulating answers for each question or problem posed.
1. Assume you are a U.S. company taking delivery of 10 million euros worth of supplies from a European company. You placed the order 6 months ago. At that time, you had the following options:
o Wait until today to purchase 10 million euros to pay your supplier. The following link takes you to data on current and past exchange rates.
o Negotiate a forward market contract (both fixed and one with options) with your bank.
o Use the Chicago Mercantile Exchange (CME) futures market for delivery of 10 million euros at the delivery date closest to but still before today's date. Use the following link to access futures market quotes.
Evaluate each of the options described above and, knowing what you know now, can you identify which would have been the best one for you? In your evaluation, determine the total cost (including any fees) to you in dollars of each option and the timing of the payment. Also discuss the exchange rate risks inherent in each of the options. Which option was riskiest? Which was the least risky? Be sure to justify your responses.
2. As you take delivery of your supplies, you negotiate with the same supplier for a delivery of another 10 million euros worth of the product 6 months in the future. Based on your analysis for part one and information available from the FX Futures Quotes and other sources, decide which currency strategy you will use. Support your answer, including the following information:
o A chart or table showing past fluctuations in the euro-dollar exchange rate-how volatile is this exchange rate?
o A chart or table showing futures market quotes for the euro-dollar exchange rate over the period between now and the next 6 to 9 months-what is the expected direction of change in the exchange rate predicted by traders?
o A discussion on the specific costs associated with using futures or forward markets versus spot market
In addition, discuss how the company's strategy may be influenced by its attitude toward risk. Does the company have the resources needed to absorb currency losses? Is the price of the product sold by the company locked in or will it be able to make adjustments based on changes in costs? Please be sure to justify all answers.
Prepare a 6- to 10-slide deck PowerPoint presentation summarizing your results and recommendations, similar to one you would present to a company's management. Be sure to include your numerical results and tables and/or charts in the presentation, as well as your rationale for your recommendations.