Minimizing Exposure Lola Co. (a U.S. firm) expects to receive 10 million euros in one year. It does not plan to hedge this transaction with a forward contract or other hedging techniques. This transaction is its only international business, and the firm is not exposed to any other form of exchange rate risk. Lola Co. plans to purchase materials for future operations, and it will send its payment for these materials in one year. The value of the materials to be purchased is approximately equal to the expected value of the receivables. Lola Co. can purchase the materials from Switzerland, Hong Kong. Canada, or the United States. Another alternative is that it could purchase one-fourth of the materials from each of those four countries. The supplies will be invoiced in the currency of the country from which they are imported.
The movements of the euro and the Swiss franc against the dollar are highly correlated and will continue to be highly correlated. The Hong Kong dollar is tied to the U.S. dollar, and Lola 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 independent of (not correlated with) the movements of other currencies against the U.S. dollar.
Lola Co. believes that none of the sources of the imports would provide a clear cost advantage. Whichalternative should Lola Co. select for obtaining supplies that will minimize its overall exchange rate risk?
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