Metro Ltd is a company which distributes and sells decorative trains for display. The company,

which is based in Australia, imports the decorative trains from the USA which it packages and sells in

New Zealand and larger countries in the Far East. The company is also considering establishing a

subsidiary in South Africa which would buy products from Metro Ltd and sell within Africa.

Metro Ltd reports its results in its home currency. The company pays for its purchases from

the USA in US dollars, but receives payment for the goods which it sells in Australia and the

Far East in local currency. All transactions carried out with the subsidiary in South Africa

would be in US dollars. The company generally takes $6$ weeks to pay its supplier in the USA

and receives payment from debtors within $4$ months.

Over the last few years the company has found that sales have been quite predictable and it has

been possible to plan sales levels and purchases of goods in advance. However, there is

increasing competition from companies in the Far East, which may make this more difficult in

the future.

Required:

$($a$)$ The company is currently considering whether the foreign currency exposure could be

managed more efficiently. Describe the following types of foreign currency exposure, giving

examples of how they could impact Metro Ltd$,$ now and in the future: $(12$ marks$)$

$($i$)$Economic risk

$3$

$($ii$)$ Translation risk

$($iii$)$Transaction risk

$($b$)$ Describe the following approaches to managing or hedging transaction exposure and the

disadvantages and advantages of each method: $(12$ marks$)$

$($i$)$Leading and lagging

$($ii$)$ Matching

$($iii$)$Forward exchange contracts

$($iv$)$Currency options

$($c$)$ Identify the factors which Metro Ltd should consider when deciding which approach to take, and

give recommendations on how Metro Ltd should manage its transaction exposure, giving reasons for

your recommendations. $(6$ marks$)$