Answered step by step
Verified Expert Solution
Question
1 Approved Answer
Rebecca Smith, an analyst in the investment management division of a financial services firm, is developing an earnings forecast for a small local dairy company
Rebecca Smith, an analyst in the investment management division of a financial services firm, is developing an earnings forecast for a small local dairy company in New Zealand (NZ). The company's revenues are closely linked to the price of global dairy commodity products, which are set by the global market and priced in US dollars (USD). All expenses of the company are incurred in the local market and denominated in NZ dollars (NZD). The strength of the NZ economy depends significantly on sales of dairy commodity products denominated in USD. As a result, movements in world dairy commodity products in US dollar terms and the value of the NZD are strongly positively correlated. That is an increase in the USD price of dairy commodities is strongly correlated with an increase in the value of the NZD against the USD. An increase in commodity prices would increase the company's sales in USD terms, all else being equal. On the other hand, the appreciation of the NZ currency relative to the USD would reduce the company's sales in terms of the home (NZ) currency. The company's chief risk officer, has made the following statement: "The company has rejected hedging the market risk of a decline in global dairy commodity prices by selling commodity futures and hedging the currency risk of a depreciation of the US dollar relative to our home currency (NZD). We have decided that a more effective risk management strategy for our company is to not hedge either market risk of commodity price changes or currency risk." Required: (a). State whether the company's decision to not hedge commodity market risk is justified. Explain your answer with at least one reason. (Please type your answers, word limit 200). (b). State whether the company's decision to not hedge currency risk is justified. Explain your answer with at least one reason. (Please type your answers, word limit 200)
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access with AI-Powered Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started