Question

You are the finance manager of a U.S. multinational firm that has sold US$6 million of high-tech product to a Chinese importer. Because of stiff competition for the contract with European and other U.S. companies , you agreed that the negotiators could sign a renminbi -based contract , although this is not standard practice for your firm. The sales contract calls for the Chinese importer to make Three equal payments at 6, 12, and 18 months from the date of Delivery, which is in 60 days . Your plan is to translate the renminbi to dollars on their receipt ; your company has no operations in China and no need for Chinese currency. You realize, Though, that this arrangement incurs transaction exposure . How could you cover this risk?

Answer 1

The date of delivery is in 2 months. The three equal payments are 6, 12 and 18 months from date of delivery, which is 8, 14 and 20 months from today.

This transaction exposure could be covered in four different ways :

• Forward hedge - Sell the renminbi forward. There will be 3 contracts sold - with 8, 14 and 20 months to maturity. Each contract value will be the value of the payment to be received. This will lock into the rate at which reminmbi can be converted into dollars.
• Futures hedge - Sell the renminbi futures contracts. There will be 3 contracts sold - with 8, 14 and 20 months to maturity. Each contract value will be the value of the payment to be received. This will lock into the rate at which reminmbi can be converted into dollars.
• Buy put options on the renminbi. If the exchange rate (in terms of dollars per renmimbi) decreases, the gains on the put options will offset the losses on currency exchange.
• Money market hedge - this involves borrowing in renmimbi the present value of the renmimbi receipt, converting into dollars at the spot rate, and using the renmimbi receipt from the customer to repay the renmimbi borrowing. This is done separately for each equal receipt of renmimbi.