A U.S. firm has borrowed £50 million from a British firm. The borrower will need to convert dollars to pounds to repay the loan when it is due. The U.S. firm could hedge the exchange rate risk by

Question

Quizplus · Accepted Answer

Buying pounds forward would help the U.S. firm hedge the exchange rate risk by locking in a predetermined exchange rate at which they can purchase the pounds needed to repay the loan. This way, if the pound strengthens against the dollar, the U.S. firm will still be able to purchase the pounds at the predetermined rate, decreasing their foreign currency exposure. Selling pounds forward or borrowing pounds would not be effective hedges in this scenario.

A US Firm Has Borrowed £50 Million from a British Firm