Lagoon (a U.S. firm) will be receiving 4 million British pounds in one year. It will need to make a payment of 3 million Polish zloty in one year. It has no other exchange rate risk at this time. However, it needs to buy supplies and can purchase them from Switzerland, Hong Kong, Canada, or Ecuador. Another alternative is that it could purchase one-fourth of the supplies from each of those 4 countries. The supplies will be invoiced in the currency of the country where they are imported from. Lagoon Co. believes that none of the sources of the imports would provide a clear cost advantage. As of today, the dollar cost of these supplies would be about $6 million regardless of the source that will provide the supplies. The spot rates today are as follows: British pound = $1.80 Swiss franc = $.60 Polish zloty = $.30 Hong Kong dollar = $.14 Canadian dollar = $.60 The movements of the pound and the Swiss franc and the Polish zloty against the dollar are highly correlated. The Hong Kong dollar is tied to the U.S. dollar and Lagoon Co. expects that it will continue to be tied to the dollar. The movements in the value of Canadian dollar against the U.S. dollar are not correlated with the movements of other currencies. Ecuador uses the U.S. dollar as its local currency. Which alternative should Laguna Co. select to minimize its overall exchange rate risk? Explain clearly.
Lagoon (a U.S. firm) will be receiving 4 million British pounds in one year. It will need to make a payment of 3 million Polish zloty in one year. It has no other exchange rate risk at this time. However, it needs to buy supplies and can purchase them from Switzerland, Hong Kong, Canada, or Ecuador. Another alternative is that it could purchase one-fourth of the supplies from each of those 4 countries. The supplies will be invoiced in the currency of the country where they are imported from. Lagoon Co. believes that none of the sources of the imports would provide a clear cost advantage. As of today, the dollar cost of these supplies would be about $6 million regardless of the source that will provide the supplies.
The spot rates today are as follows:
British pound = $1.80
Swiss franc = $.60
Polish zloty = $.30
Hong Kong dollar = $.14
Canadian dollar = $.60
The movements of the pound and the Swiss franc and the Polish zloty against the dollar are highly correlated. The Hong Kong dollar is tied to the U.S. dollar and Lagoon Co. expects that it will continue to be tied to the dollar. The movements in the value of Canadian dollar against the U.S. dollar are not correlated with the movements of other currencies. Ecuador uses the U.S. dollar as its local currency.
Which alternative should Laguna Co. select to minimize its overall exchange rate risk? Explain clearly.
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