Explanation:
A lot can change in 12 months. If the USD appreciates significantly against the CAD, the project will become more expensive, and its internal rate of return will decrease. To hedge that risk, the company could take a position in a currency futures contract to lock in the value of the CAD versus the USD.
Option A is incorrect. Launching the project earlier than planned may help for some time but the company will still suffer when the CAD depreciates over the USD.
Option C is incorrect. Purchasing stock index futures is used to hedge against the risk of fluctuation in market prices.
Option D is incorrect. Paying for some upfront costs of the project immediately may reduce future costs however, the company will still suffer from the effects of the currency depreciation.
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Q.17 A Canadian company harbors an ambitious plan to launch a project in the U.S. in twelve months. The company uses the Canadian dollar as the functional currency, and the project would most likely be executed in U.S. dollars. However, the company's top management is worried that the CAD will weaken against the USD in the months leading up to the beginning of the project, which might, in turn, increase the amount the company will have to pay for the project. As the company's risk manager, which of the following business strategies would work best regarding the foreign exchange risk?
A
Launching the project earlier than planned.
B
Take a hedging position in the form of a currency futures contract.
C
Advise the company to purchase stock index futures.
D
Immediately pay for some upfront costs of the project.
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