A Chinese exporter has agreed to supply toys to a US retaile

A Chinese exporter has agreed to supply toys to a US retailer, being paid in Yuan at the equivalent of US$50 each. In this arrangement, who is exposed to FX risk? How can this exposed company hedge its FX risk?

Solution

Since the US retailer is payng fixed rat 50$, it is not exposed to FX risk.

The Chinese counterpart is exposed to FX risk because his earning would depend on the USD/YUAN rate since he would be receiving 50$ irrespective of the exchange rate. If the Yuan depreciates, he would receive more in terms of YUAN but if it appreciates, he would receive lesser.

Since the exporter knows the USD equivalent of the receipts, he can enter into a forward contract to hedge the foreign currency risk.