Financial Risk Manager Part 1
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An international construction company places a bid for a major construction project. Top management is convinced the company will secure the contract but are also wary of currency fluctuations during the bids evaluation process, which would make the project more costly and reduce the profit margin. Which of the following actions do you think can reduce this risk?
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A
Negotiating the price of construction materials with sellers in advance
B
Purchasing construction materials in advance with the option to sell them if the bid turns out unsuccessful
C
Getting into a currency futures contract
D
Adding a risk premium to the bid amount
Explanation:
Explanation
Using a currency futures contract, the company can price the bid quoting current market rates and then use the futures contract to hedge its exposure to currency fluctuation. This way, the company would ensure that even if the market rates change, the bid would be sufficient to undertake the project and earn a profit.
Why Option A is incorrect: Prices may be negotiated in advance; however, without a contract, then you will still buy the materials at the prevailing market prices in case the prices rise, since stocks may also rise in price.
Why Option B is incorrect: A lot may happen with time. The price of the materials may rise, and therefore purchasing construction materials in advance with the option to sell them if the bid turns out unsuccessful will not help reduce the risk.
Why Option D is incorrect: The owner of the project pays the risk premium in advance and if the risk does not materialize, then this will only benefit the contractor of the project.
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