Currency Hedging Strategies for International Tech Solutions

A U.S.-based multinational corporation, International Tech Solutions (ITS), generates 40% of its revenue from Europe, primarily in euros. Due to recent volatility in the EUR/USD exchange rate, the CFO of ITS is considering various currency hedging strategies to mitigate the risk associated with foreign currency fluctuations from their European revenue streams.

The CFO is contemplating two primary strategies: a forward contract to lock in the current exchange rate for the next 12 months, and a currency option that would provide the right, but not the obligation, to exchange euros for dollars at a predetermined rate. In addition, the CFO is considering the implications of these hedging strategies on the company’s cash flows, as well as the potential impact on the overall profitability and financial statements.

Discuss the advantages and disadvantages of both hedging strategies in the context of ITS's situation. Additionally, consider how the decision to hedge, or not to hedge, may affect earnings volatility and the firm’s valuation. Conclude with a recommendation based on your analysis.