The currency exchange risks can be a serious issue for any company as it is something that cannot be under absolute control. Taking into account that the company has no option than to buy raw materials in Japan, the safest method is hedging. Hedging refers to an ability to minimize or prevent currency exchange risks in the future (Avadhani, 2010). For instance, the company can use a forward contract to preserve the current rates for the purchases in the future. It is a type of a formal agreement between two or more parties regarding purchases of the specific product, material, or asset in the future with the current prices and rates. However, it has to include the exact time when the purchase will occur.
It is the safest and the cheapest option for the company as it helps to maintain the same currency exchange rate, even though it might increase. The forward contract has an obligatory status for all of the parties which means that the Japanese partner will not be able to refuse from one’s duties even when the currency rates increases. Apart from that, the company must buy the raw materials in the future in order to avoid the breach of contract (Avadhani, 2010). Furthermore, the agreement can use various time frames, depending on the goals of the parties. For instance, the forward contract can be used to determine 2-5 years in the future, or even more. It also can be used in courts in order to resolve any violations of the terms of the agreement which is good leverage for the company.
In addition, there is also an option which serves as a right for the company to buy the specific product in the future with a particular price. The primary reason to use the method is the fact that the company will not be obliged to buy this product, it will have an opportunity to choose. Even though for now there is no alternative to Japanese partners, it is still possible it can appear in the future. The long-term hedging is a risk and should not exceed the prediction in 3-5 years in the future as the situation will change and new norms will appear. However, the forward contract and the option are the two safest and cheapest methods of hedging for the company. They can secure the position of the company in the nearest future and minimize the currency exchange risks.
References
Agarwal, O. (2009). Chapter 5: Foreign exchange risks. In International financial management. Mumbai, India: Himalaya Pub. House.
Avadhani, V. (2010). Chapter 7: Management of international transaction exposure. Accordingly. In International financial management. Mumbai, India: Himalaya Pub. House.
Shackman, J. (2015). The economic and financial environment of international business. Trident University International, Cypress, CA.