Assume your US firm currently exports to mexico on a monthly basis. The goods ar

Question

Assume your US firm currently exports to mexico on a monthly basis. The goods are priced in Mexican Pesos (MXN). Once material is received from a supplier, is used to produce goods in the US and then exported. Currently, you have no other exposure to exchange rate risk. You can purchase material from Canada, Mexico or from within the US. You expect the quality and price to be similar no matter where the materials are sourced. 1. Assuming you are interested in lowering exchange rate risk, your best option would to:

A-Source the goods in Mexico

B-Source the goods in Canada

C- Source the goods in US

D- Source from Canada, US, and Mexico in equal proportion

2. Suppose you work out a deal with the Mexican customer to price the exported goods in USD and then source the materials in the US. Have you completely eliminated exchange rate risk?

A- You've eliminated all exchange rate risk

B- You've eliminated economic risk but not transactions risk

C- You've eliminated transactions risk but not economic risk

D- You haven't eliminated any type of exchange rate risk

Explanation / Answer

1. A) Source the goods in Mexico

This is because if the raw materials as well as the finished products are priced in Mexican Pesos (MXN), the fluctuations in USD - MXN exchange rate will not affect the price paid or received, thereby lowering the exchange rate risk.

2. B) You've eliminated all exchange rate risk

Pricing the exported goods in USD and sourcing the raw materials from the US (in USD) eliminates the exchange rate risk and the risk associated with governmental regulations in Mexico, i.e. the economic risk is eliminated. Also, since there is no currency exchange from USD to MXN (or the other way round) taking place, there is no transaction risk as well.

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