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Hedging refers to a type of insurance which greatly helps in reducing the financial risk that a company can incur. In addition, a hedge refers to an investment position that is aimed at offsetting any potential gains or losses that may be incurred by a firm. Hedging can be used by various firms through different ways which may include trading in foreign currency. . Given the information in this question, the forward hedge was the most appropriate since there was a probability of the money market rates increasing in future and thus the forward hedge would ensure that Carbondale Co. gains considerably due to a rise in the future spot rate. On the most appropriate hedge towards an un-hedged strategy, then the currency options hedge is the most appropriate since it will be based on the money market rates that will be prevailing at the time. Carbondale should therefore hedge its receivables position since it will lead to an increased profit margin for the company.

Question 34

As a US importer of products from Europe, the September 11 2001 terrorist attack on the U.S would have caused the hedging of the payables dominated in Euros that were due a few months later as the attack led to a plethora of problems for the U.S investors. The attack led to a jittery market in the United States that would have been hard to predict even though there was a reduction in interest rates. Thus hedging the payables would have insured a safe option for the funds as most investors, especially short term ones would have opted for the Euro market thus reducing the value of the dollar further. Since pressure on the equity markets would have affected the preference of the markets (money markets) (Sexton, et al. 2011).

 

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Chapter 10

19. Erie Co. which mainly operates its businesses in the U.S.A but exports to Belgium used to invoice its exports in Euros. Since the company’s competition is a Belgium firm with products denominated in Euros, Erie’s new strategy of invoicing its exports in US dollars gives it an advantage due to the present strength of the dollar. Erie Co. will certainly be exposed to economic exposure in the future due mainly to the risks associated with exchange rate fluctuations. If the dollar gains strength against the Euro, customers in Belgium might prefer the local competitor due to a cheaper product because of the stronger dollar. With this new strategy, Erie’s company will therefore be subject to economic risk due to the fact that invoicing in US dollars can either have a positive or negative exposure.

Question 25

Though the U.K has its own currency, the pound which is historically stronger than the Euros interest rates, there have been arguments about this, whether to adopt the Euro as its currency or not. Many likely effects can accrue due to this.

Since no currencies would be required, there will be a decrease in economic exposure of the British companies or firms which are heavy exporters to the Euro zone.

(b) The translation exposure of companies which are located in Euro regions having the British subsidiaries could decline or decrease since there would be no use of translating the British financial statements.

(c) The United States firms’ economic exposure  which conduct substantial business operations in the United Kingdom and which do not run any other international; businesses will decrease because the euro should be less volatile as opposed to the pound. 

(d) The exposure of translation of the United States firms together with the British subsidiaries will decrease because the euro should be less volatile than the pound.

(e) The United States firms’ economic exposure which exports to the United Kingdom and whose other global business operations is doing imports from companies located in the Euro zone will decrease because their euro outflows are capable of offsetting some of the inflows in euro.

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(f) The forward discount placed on the rate of forwarding which is paid by firms in the United States which use forward markets periodically to hedge the payables of the British imports could decline or reduce (or even be a premium) since the euros interest rate is normally less than the pounds’ interest rate

(g) The earnings from the a British Bank’s foreign exchange Department which executes transactions in foreign currency which are desired by the European customers will decrease since there will be a reduction in the foreign exchange required.

Chapter 10: Measuring of Exposure towards Exchange Rate Fluctuations.

(h) If it is assumed that Swiss Franc will be more correlated to British pound as opposed to the Euro, while United States firm also has monthly exports to the United Kingdom which are substantial and they are denominated in British Currency and further assumed that the company has monthly imports which are substantial of the import supplies which are denominated in the Swiss Francs, then the economic exposure of such a company will definitely increase since it would replace the pound with the euro. The pound effects offset the Swiss franc effects because of the high correlation. The euro effects will not have as much of an offsetting impact since it was assumed that the correlation is not as high.

(j) If it assumed the Swiss Franc will be most likely correlated with the British Currency and a United States company has a monthly export which are substantial to the United Kingdom which are actually denominated in British currency while it also has monthly exports which are substantial to Switzerland and which are in Swiss Francs. Such a company’s economic exposure would then decrease since the cash inflows will come from currencies which don’t move in tandem like before. The reliance o the British government on the monetary policy instead of the fiscal policy in order to fine tune its economy will decrease since the country would not have the control of the country’s money supply.