Tennessee Co. conducts business in the United States and Canada. The net cash flows from Canadian operations are expected to be C$500,000 next year. The Canadian dollar is valued at about $.90. The net cash flows from U.S. operations are expected to be $200,000. To reduce the sensitivity of its net cash flows without reducing its volume of business in Canada, Tennessee Co. could:

Question

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By purchasing Canadian supplies, Tennessee Co. can use up the excess Canadian dollars it receives from its Canadian operations, reducing its foreign exchange risk by not having to convert those Canadian dollars back to U.S. dollars. This will also provide a natural hedge against any currency fluctuations. Increasing borrowings in the United States or decreasing borrowed funds in Canada may not be feasible or practical options for Tennessee Co. at this time. Decreasing prices on Canadian goods may impact the company's profitability and may not necessarily reduce its foreign exchange risk.