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

Quizplus · Accepted Answer

By purchasing Canadian supplies, Tennessee Co. can decrease its exposure to currency risk since it is balancing out its cash flows with expenses in Canadian dollars. This will reduce the sensitivity of its net cash flows without reducing its volume of business in Canada. Increasing its borrowings in the United States (option B) may not necessarily reduce the currency risk, as it will increase the exposure to USD currency risk. Decreasing prices on Canadian goods (option C) may lead to reduced profitability and competitiveness in the market. Decreasing its borrowed funds in Canada (option D) may not necessarily reduce currency risk since it is the net cash flows that are exposed to currency fluctuations.