Suppose a U.S.bank borrows money in London while a British company borrows money in New York.At the end of the loan period the U.S.company needs pounds to repay their loan and the British company needs dollars to repay their loan.Which of the following might be a good tool for these companies to reduce their currency risk?

Question

Quizplus · Accepted Answer

A currency swap contract would be the best tool for these companies to reduce their currency risk. In this arrangement, the U.S. bank and the British company can swap the currencies they need to repay their respective loans, thereby avoiding the need to convert currencies in the open market and being exposed to currency risk. This way, each borrower can repay their loan in their home currency, eliminating exchange rate uncertainty. Futures and options contracts may be used to hedge currency risk, but they are not as versatile as a currency swap. Interest rate futures and interest rate swap contracts are not relevant to this situation as they do not address currency risk.