The function of foreign exchange in practice for the company is hedging. The organization is participating in international trade where the customers of the cross-boundary units pay for goods and services using their local money. The unpredictability of the nations’ currency poses a significant risk of depreciation, increasing the venture’s cost. Thus, the firm intends to insure itself against the changes between the Canadian dollar and the other country’s legal tender. In essence, the management does not expect any profits from the convertibility transaction. Therefore, this paper explains the reason why hedging is the process that ensures constant monetary value.
Involvement in a free foreign exchange market can yield either a profit or a loss depending on the change in the relative price of two currencies. Notably, the company does not focus on the benefit arising from a profit as such interest would make the business responsible for arising losses. Hedging incorporates forward contracts within the conversion process to reduce risks. According to Hendrawan (2017), the contract incorporates a written agreement to trade foreign exchange against a particular currency at a pre-set future date at a fixed price. A client cannot get the money within the commitment period. However, after the deal expires, the firm receives Canadian dollars at the discussed rates even if the value has depreciated. Hedging ensures predictability as the firm can know the expected amount at the end of a set period which facilitates planning. Nevertheless, it is not a hundred percent cost-efficient as it has to pay for accounting and control strategies (Hernawaty et al., 2020). In conclusion, the company prefers the foreign exchange hedge process to avoid significant fluctuations in monetary value.
References
Hendrawan, R. (2017). Forward, forward option, and no hedging which one is the best for managing currency risk. Journal of Finance and Economics, 21(3), 356-365. Web.
Hernawaty, H., Chrisna, H., & Junawan, J. (2020). Analysis of the use of forwarding contract hedging export value of economic goods in North Sumatra province. Journal of AKMAMI (Economic, Management, and Accounting), 1(3), 95-109. Web.