Question 13.4: Consider goods from United States to be sold to some Europea...
Consider goods from United States to be sold to some European company for 100,000,000 €. To eliminate the FX risk, the exporter can contract to deliver 100,000,000 € to his bank in 30 days in exchange for payment of $110,000,000. Such a forward contract will ensure that the US exporter can convert the money regardless of what may happen to the dollar-yen exchange rate over the next 30 days. However, if the Japanese buyer fails to pay on time, the US exporter will be anyway obligated to deliver the 100,000,000 € in 30 days.
It is advisable for an exporter to enter into forwards with conservative delivery dates. In case the currency is collected sooner, the exporter can hold on to it until the delivery date or can “swap” the old FX contract for a new one with a new delivery date at a minimal cost.
In case of the future completion of some FX deal, it is therefore worth to consider FX options. The option allows the exporter to acquire the right to deliver the agreed amount of foreign currency to the lender in exchange for dollars at a specified rate on or before the expiration date of the option.
The option is similar to a premium paid for an insurance policy. If the value of the foreign currency goes down, the exporter is protected from loss. On the other hand, if the value of the foreign currency goes up significantly, the exporter can sell the option back to the lender or simply let it expire by selling the foreign currency on the spot market for more dollars than originally expected, but the fee would be forfeited.