Suppose that the G Company knows that in one month it must pay £7 million for goods that its U.S. subsidiary will receive in Britain. The current exchange rate is $1.99£. The risk that the corporate treasurer faces is that
A)the $US/pound exchange rate falls in a month's time (i.e., the pound weakens).
B)the $US/pound exchange rate rises in a month's time (i.e., the pound strengthens).
C)the $US/pound exchange rate does not change from its current position.
D)the pound exchange rate falls in a month's time (i.e., the pound strengthens).

Question

Quizplus · Accepted Answer

The risk faced by the corporate treasurer is that the $US/pound exchange rate rises in a month's time (i.e., the pound strengthens). If the exchange rate rises to, say, $2.05£, the G Company will have to pay $14.35 million for the goods instead of $13.93 million (which it would have to pay if the exchange rate stayed at $1.99£). This will increase the cost of the goods for the G Company by $420,000, which is a significant amount. Therefore, the corporate treasurer needs to be prepared for this risk and take appropriate measures to hedge against it.

Suppose That the G Company Knows That in One Month