Forward Contracts in Currency Risk Hedging

Very Hard Multinational Operations Hedging Currency Risk

ABC Corporation is a multinational company based in the United States that generates substantial revenues from Europe, bringing in €50 million annually. The company has significant exposure to currency risk due to fluctuations in the EUR/USD exchange rate, which can impact its financial results when converting euros to dollars. Currently, the management at ABC is considering different hedging strategies to mitigate this risk.

They are analyzing three different strategies: using forward contracts, options, and natural hedging methods. Each strategy has its own implications in terms of cost, flexibility, and effectiveness in different currency market conditions.

Given this context, which of the following statements is true regarding the use of forward contracts as a hedging strategy for ABC Corporation?

Using forward contracts locks in the exchange rate but offers no flexibility if the exchange rate moves favorably.

Forward contracts require an upfront premium payment to secure the exchange rate.

Forward contracts manage currency risk effectively without the risk of counterparty default.

Hint

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