Foreign Exchange Risk Management Strategies for Xinjiang Company

FIN61104 INDIVIDUAL ASSIGNMENT

TABLE OF CONTENTS
Introduction......................................................................................................................................3
A and B) Risk management strategies and justification..................................................................3
C).....................................................................................................................................................7
(i)..................................................................................................................................................7
(ii)................................................................................................................................................8
D).....................................................................................................................................................9
(i)..................................................................................................................................................9
(ii)..............................................................................................................................................10
References......................................................................................................................................11

INTRODUCTION
Foreign exchange risk exposure refers to the financial risk which arises due to the financial
transactions stated in the foreign currency, which is other than the domestic currency (Fleten et
al. 2015). Due to the high volatility in the currency rates, the profit of the investor is significantly
affected (Bettis, Bizjak and Kalpathy, 2015). There are three types of foreign risk exposure such
as transaction exposure, operating exposure and translation exposure (Islam, and Chakraborti,
2015). However through the effective manner of the hedging, the foreign exchange risk can be
mitigated to some extent, some hedging techniques are described below-
1. To hedge with by entering into the forward contract
2. Hedging the risk by money market hedging
3. By entering into the option contract (Bhatia, and Bhat,2016)
In the present study, Xinjiang company which is China-based will receive the amount of $ 50
million in future by entering into the deal in June 2017. On the basis of the terms of the deal,
50% of the amount will receive in December 2017 and another 50% in June 2018. The company
has foreign exchange risk exposure due to the changing in the foreign currency rates. And if the
value of the dollar will decrease, then there is a chance of the loss to the company. Therefore the
company wants to hedge the foreign currency risk exposure. Through the following method, the
company can hedge the risk.
A AND B) RISK MANAGEMENT STRATEGIES AND JUSTIFICATION
Through the forward contract

If the company wants to cover its risk exposure through the forward contract, then the company
will sale $ 25 Million forward contracts today at the 180 days forward rate and remaining $25
million forward contracts today at 360 days forward rate.
The 180-days forward rate= 1 $= CNY 6.62335
In 180 days company will receive $ 25 Million and sale this $ at the CNY 6.62335 and receive
the CNY 165.584 M.
The 360-days forward rate= 1 $= CNY 6.22755
In 180 days company will receive $ 25 Million and sale this $ at the CNY 6.22755 and receive
the CNY 155.689 M.
The amount computed above is certain. In the future, the amount will not be impacted by any
volatility in the foreign exchange risk.
Through money market hedge
In the money market hedge technique, the company can hedge the amount by borrowing which is
equal to the present value of the amount of foreign currency, and after this, the borrowed amount
converted into the domestic currency through the spot rate. The amount will be invested into the
domestic currency, and the amount received in the maturity will be along with the interest rate.
Hedging of the amount which will be received in December 2017
Step 1. Borrow the $ 25 Million at the rate prevailing in the US that is at 4%. The present value
of the borrowed amount = $ 25 Million/1.04= $ 24.038 M.
So, the company will borrow the $ 24.038 M today and repay the amount with interest