CFA Level 2
Financial Reporting and Analysis

Hedging Currency Risk with Forward Contracts

Medium Multinational Operations Hedging Currency Risk

Global Tech Inc. is a U.S.-based multinational corporation that earns significant revenue in euros from its operations across Europe. As the euro has recently depreciated against the U.S. dollar, the management of Global Tech is concerned about the potential impact on its future cash flows when converting euro revenues to U.S. dollars. To hedge against currency risk, Global Tech is considering several options.

The CFO proposed implementing a foreign currency forward contract that allows the company to lock in a specific exchange rate for a future date to mitigate the risk of adverse currency movements. The company is evaluating this option against two alternative strategies:

  • Using options to hedge against unfavorable exchange rates.
  • Keeping its euro-denominated revenues without any hedging strategy.

Which of the following best describes the advantages of using a foreign currency forward contract for hedging compared to the alternatives?

Hint

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