You work for a company where the CFO thinks that the value of the firm's assets fluctuate widely with the euro-dollar exchange rate does not want to hedge the firm's exchange rate risk because he thinks it is impossible. How can you convince him to hedge?
What will be an ideal response?
Answer: In order to hedge the euro-dollar exchange rate, it is necessary to first understand the relationship of the dollar to the euro. If we find that the value of the firm goes up when the euro strengthens relative to the dollar and the value of the firm is low when the euro is weak versus the dollar, then the firm has euro assets whose dollar value increases when the euro appreciates. An appropriate hedging strategy to describe to the CFO is one where some of the firm's debt would be denominated in euro. Euro liabilities will increase in value when the euro strengthens. The firm could also sell euro forward. There would be profits when the future exchange rate of the euro per dollar rose unexpectedly, that is when the euro weakened and the value of the firm was low.
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