BBMF2103 – INTERNATIONAL TRADE FINANCE.

TUTORIAL

1. What is transaction exposure?

Transaction exposure equals the net amount of foreign-currency-denominated transactions already

entered into. On settlement, these transactions may give rise to currency gains or losses. Transaction
exposure is often included in accounting exposures. It also as a cash-flow exposure, it is rightly part
of economic exposure

2. Sun Microsystems has decided to hedge its foreign receivables only when it believes the dollar will
strengthen. Otherwise, it will go uncovered. Comment on the risk/s for this policy

Sun Microsystems' decision to hedge its foreign receivables only when it anticipates the dollar will
strengthen exposes it to significant currency risk when the dollar weakens. By leaving receivables
uncovered during these periods, the company risks potential losses due to unfavorable exchange rate
fluctuations. This strategy may offer short-term gains if the dollar strengthens as predicted, but it
also leaves the company vulnerable to unexpected currency depreciation, which could negatively
impact its financial performance. Additionally, this approach may lack consistency and could lead to
uncertainty in financial planning and forecasting.

3. Dell Inc. produces its machines in Asia with components largely imported from the U.S. and sells its
products in various Asian nations in local currencies.

a. What is the likely impact on Dell’s Asian profits of a strengthened dollar?

A strengthened dollar would likely have a negative impact on Dell's Asian profits. When the dollar
strengthens, it means that the local currencies in Asia would weaken in comparison, leading to lower
revenue in dollar terms when converted. Since Dell sells its products in local currencies, when those
currencies are converted back to dollars for financial reporting purposes, the revenue earned in those
currencies would translate into fewer dollars, reducing profits.

b. What hedging technique(s) can Dell employ to lock in a desired currency conversion rate for its?
Asian sales during the next To hedge against currency fluctuations and lock in a desired currency
conversion rate for its Asian sales, Dell can use several techniques:

Forward Contracts: Dell can enter into forward contracts with financial institutions to buy or sell a
specific amount of currency at a predetermined exchange rate at a future date. This would help Dell
lock in the exchange rate for its future transactions, mitigating the risk of currency fluctuations.

Currency Options: Dell can also purchase currency options, which give it the right, but not the
obligation, to buy or sell a specific amount of currency at a predetermined exchange rate within a
specified period. This provides Dell with flexibility while still allowing it to protect against
unfavorable currency movements.year?

c. Suppose Dell wishes to lock in a specific conversion rate but does not want to foreclose the
possibility of profiting from future currency moves. What hedging technique would be most likely to
achieve this objective?

If Dell wishes to lock in a specific conversion rate but still wants to profit from favorable currency
moves, it can use a combination of hedging techniques:

Participating Forward Contracts: Dell can use participating forward contracts, which allow it to
participate partially in favorable currency movements while still providing downside protection. In
this arrangement, Dell agrees to a minimum exchange rate for its currency conversion but also
benefits from any favorable movements beyond that rate up to a predetermined cap.

Collars: Dell can also implement a collar strategy, which involves simultaneously buying a
protective put option and selling a covered call option on the currency. This sets a floor and a ceiling
on the exchange rate, providing downside protection while still allowing some upside potential. If
the currency moves unfavorably, Dell can exercise the put option to sell at the predetermined floor
rate, but if the currency moves favorably, Dell's gains are limited to the cap set by the call option.