Derivatives and Alternative Investment

Running head: DERIVATIVES AND ALTERNATIVE INSTRUMENTS
Derivatives and Alternative Investment
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1DERIVATIVES AND ALTERNATIVE INVESTMENTS
Table of Contents
In Response to Question 1..........................................................................................................2
In Response to Question 2..........................................................................................................5
In Response to Question 3..........................................................................................................8
Reference..................................................................................................................................12

2DERIVATIVES AND ALTERNATIVE INVESTMENTS
In Response to Question 1
Investment in foreign currency assets involves has its pros and cons and is dependent
on an individual investor how an investment strategy is constructed for mitigating and
overcoming the risk associated with the overseas investment. Foreign investment result in
foreign currency risk and which is ultimately dependent on the various business factors and
conditions under which the company operates. There are many factors that influences the
movement of the foreign exchange rates in which the company operates the macro-economic
conditions and the business factors plays a significant role (Prampolini and Morini 2017). It
is necessary for the Adventure Planet Inc. to forecast and asses the key factors, which could
significantly influence the exchange rate in the economy. The prevailing level of interest rate,
inflation rate in the economy and the global macro condition are some of the factors, which
significantly influence the foreign currency rate, and the same should be analyzed by the
Adventure Plc Inc. Foreign exchange risk influences the company in the form of financial
risk and results in volatile financial position of the company (Kieschnick and Rotenberg
2016). Adventure Planet Inc. is a US based company but is having its operation based is
Austria the functional currency for the company is the Euro Dollars and the reporting
currency for the company is the Dollars (Ramirez 2015). The volatility in the Euro dollars
will affect the company financial position and the same will result in financial gain or loss for
the company in the form of forex gain/loss. The company should mitigate the risk associated
with the foreign currency by applying effective trading strategies and hedging techniques.
The strengthening of the US Dollars in comparison to the Euro dollars will affect the
company in the term of exchange loss arrived for the company, which will destroy the
profitability for the company. The company should use derivative contracts such as Forward
contract and currency options in order to mitigate the risk associated with foreign investment
(Schied and Voloshchenko 2016).

3DERIVATIVES AND ALTERNATIVE INVESTMENTS
The risk identified for the company with the foreign investment in the Euro dollars is
known as currency risk. Currency risk is the risk associated with the movement of the
functional currency of company in respect to the reporting currency of the company
(Bouchard and Chassagneux 2016). The application of forward contract involves an
agreement between the two common parties interested to buy or sell an asset on a specific
date and at a specific price. The contract will be helpful for the companies in mitigating and
hedging the foreign exchange risk associated with the foreign investment (Hoberg and Moon
2017). The application of the foreign contract will enable the company in mitigation of the
risk and locking in a specified amount of value. The application of currency forward contract
would require the Adventure Inc. Company to deposit an initial deposit amount with the
currency broker (Leoni, Vandaele and Vanmaele 2014). The company can enter into the
forward contract with current or the prevailing exchange rate that is 1.25 U.S Dollars for one
Euro and lock in the specific rate for the purpose of settlement at that specific rate. There will
two outcomes possible in this type of scenario the U.S Dollars can strengthen in comparison
to the Euro Dollars. The U.S Dollars in contrast to Euro dollars can move to around 1.15 $/£.
In this scenario the loss that will be incurred by the company while exchanging the amount
would be recovered from the forward contract done by the company such that the financial
position for the company remains unaffected. The other scenario under this case will be
weakening of the US dollars and the value of the US Dollars to Euro dollars would be around
1.35 $/£. The company will be exchanging the amount at 1.35 $/£ and the relevant loss
incurred in the forward contract to the tune of 0.10 $/£ will make the effective exchange rate
of the company stable at an effective rate of 1.25 $/£. Thus, the option of applying the
forward contract in the context of hedging the transaction will make the effective currency
exchange rate of the company at the current rate.