Question 2 25 points A firm based in India agrees to buy 10

Question 2 (25 points) A firm based in India agrees to buy 10 million Euros worth of goods from a firm based in Italy. The Indian firm agrees to pay in Euros in 60 days. You are the CFO of the Indian firm. You know that the Euro has been weakening against the Rupee and expect this trend to continue for at least the next 60 days. a. Describe in detail three hedging strategies you would consider using to ensure that when your firm makes the payment in 60 days, it minimizes its risk of loss converting Rupees to Euros. (15 points) b. Does this problem illustrate translation or transaction risk? (5 points) c. Briefly describe the difference between hedging and speculation. (5 points) Question 3 (20 points) Describe the importance of a functional legal system to foreign investors. Provide three examples of how a functional legal system is important to foreign investors. Describe the importance of political stability to foreign investors. Provide two examples of hovw political stability is important to foreign investors.

Solution

2a) The following are some of the observed strategies:

b) This is considered to be a transaction risk. Because the transaction risk usually takes place on receivable or payables from exports or import contracts. The risk can take place in a short time frame (i.e. the time between contracting & payment) is relatively short. Hence the above example explains only a transaction & not a translation risk.

c) Differences between hedging & speculation:

Speculation involves making profit from a price change of a security whereas hedging tries to reduce the amount of risk or volatility that is related to a particular stock’s price change. Speculation on the other hand involves earning profit from betting on the direction in which the asset moves. Hedging on the other hand involves offsetting a position in a derivative to balance the gains & losses of the underlying asset.

3) Importance of legal system to foreign investors:

Examples are if an investor invests in country other than his home country, the legal rules will help him to know the procedures to make the investment like without paying any bribes etc to buy the stocks to the brokers or any other agents.

Legal system will help the investor to know the level of risk on a particular stock & the measures to be taken to reduce the risk legally.

Importance of political stability: