Exchange Risk Management
Vogl Co. is a U.S. firm conducting a financial plan for the next year. It has no foreign subsidiaries, but more than half of its sales are from exports. Its foreign cash inflows to be received from exporting and cash outflows to be paid for imported supplies over the next year are shown in the following table
1. Based on the information provided, determine Vogl’s net exposure to each foreign currency in dollars.
2. Assume that today’s spot rate is used as a forecast of the future spot rate 1 year from now. The New Zealand dollar, Mexican peso, and Singapore dollar are expected to move in tandem against the U.S. dollar over the next year. The Canadian dollar’s movements are expected to be unrelated to movements of the other currencies. Since exchange rates are difficult to predict, the forecasted net dollar cash flows per currency may be inaccurate. Do you anticipate any offsetting exchange rate effects from whatever exchange movements do occur? Explain.
3. Given the forecast of the Canadian dollar along with the forward rate of the Canadian dollar, what is the expected increase or decrease in dollar cash flows that would result from hedging the net cash flows in Canadian dollars? Would you hedge the Canadian dollar position?
4. Assume that the Canadian dollar net inflows may range from C$20 million to C$40 million over the next year. Explain the risk of hedging C$30 million in net inflows. How can Vogl Co. avoid such a risk? Is there any tradeoff resulting from your strategy to avoid that risk?
5. Vogl Co. recognizes that its year-to-year hedging strategy hedges the risk only over a given year and does not insulate it from long-term trends in the Canadian dollar’s value. It has considered establishing a subsidiary in Canada. The goods would be sent from the United States to the Canadian subsidiary and distributed by the subsidiary. The proceeds received would be reinvested by the Canadian subsidiary in Canada. In this way, Vogl Co. would not have to convert Canadian dollars to U.S. dollars each year. Has Vogl eliminated its exposure to exchange rate risk by using this strategy? Explain.