Merton Electronics Corporation

Merton Electronic Corporation

Question 1

Transaction Exposure is the risk faced by companies involved in global or international trade as a result of fluctuations in the currency exchange rate. This risk is relevant for situations when a company has entered a financial obligation. The methods to reduce transaction exposure are:

1. Transfer the exposure to another company. This can be done through quoting the sales price of your product in your domestic currency. For example if a Canadian firm sells to a Pakistani firm, the Canadian firm can reduce transaction exposure by quoting the price of its products in CAD dollars instead of Rupees.

2. Demand immediate payment. This is done by quoting the sales price in the foreign currency but demanding payment at time of sale in order to reduce any fluctuations due to passage of time.

3. Hedge.

Economic exposure is the extent to which a company is affected by to unexpected fluctuations in exchange rates. This exposure only considers unexpected fluctuations, as expected fluctuations would have already been discounted and reflected in the value of the firm.

Translation exposure is the extent to which a company’s consolidated financial statements are affected by changes in exchange rates, with the assumption that a company has subsidiaries in foreign jurisdictions that transact in a different currency.

Question 2

Forward-Contract hedge

Calculation:$3,000,000 * 0.7968 = $2,390,400 USD

Forward Contract hedges are the riskiest hedging instrument because there is considerable uncertainty with regards to the future sport rate. This results in high volatility and a wide range of outcomes.

Futures- Contract Hedge

Calculation: $3,000,000 * 0.8031 = $2,409,300 USD

Futures contracts are less risky than forwards for two mains reasons: 1) they trade on an organized exchange and therefore have a liquid market, and 2) the mark-to-market feature eliminates the risk of default.

Money Market Hedge...