Hedging Project Risk. Your firm has just tendered for a contract in Japan.

QUESTION

Hedging Project Risk. Your firm has just tendered for a contract in Japan. You would not know for 3 months whether you get the contract but if you do, you will receive a payment of 10 million 1 year from now. You are worried that if the yen declines in value. the dollar value of this payment will be less than you expect and the project could even show a loss. Discuss the possible ways that you could protect the firm against a decline in the value of the yen. Illustrate the possible outcomes if you do get the contract and if you do not.
In this case we can clearly state that the firm is exposed to foreign exposure as it has foreign curreny receivable 1 year from now if it gets the contract . Since it may have foreign currency receivable i.e yen it is afraid of yen falling against dollar the firm is risk everseand so it should hedge itselfwith forward cover . Forward cover means that the company will sell yen 10 million 1 year hence at a predecided rate even if Yen falls against dollar after a year and the companys dollar receivable will not decrease from that planned . Posssible outcomes : If firm gets the contract If the firm gets the contract then the company played well by making a forward cover as now the company can sell the foreign currency receivable i.e Yen 10 million at a pre decided rate

d the dollar income wont be effected even if the foreign currency depreciates as the firm would sell at a pre decided rate . If firm does not get the contract If the firm does not get the contract then it can reverse the forward contract of selling yen 10 milion by making a forward contract of buying yen 10 million 9 months forward after 3 months and that shall square of the sale contract and the firm would not incur any heavy loss apart from the rate changes in those 3 months which could be profitable or otherwise .

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