Case Study Baker Adhesive

Exchange-rate risk is a financial risk that exists when a company engaged in a financial transaction which is denominated in a currency other than the base currency of the company. It may affect the profitability of the company, therefore, a good finance manager should not only manage the financing well, but also able to manage the exchange-rate risk. In Baker Adhesive case, Baker was suffer one of the type of exchange-rate risk named transaction exposure. Baker has a contractual cash flows with Novo whose values are subject to unanticipated changes in exchange rates due to the order was denominated in foreign currency, Brazilian Reais (BRL). Thus, Baker face a risk of changes in the exchange risk between base currency, U.S. dollar and Brazilian Reais. In spite of this, there are several foreign exchange hedging strategies can be used to reduce the exchange-rate risk. With the either use of money markets or derivatives tools such as options and forward contracts, Baker Adhesive could manage and mitigate the transaction exposure that
It will give Baker the right, but not the obligation, to deliver an agreed amount of foreign currency to the lender in exchange of U.S. dollars at a specified rate on or before the expiration date of the option. Nevertheless, the option contains a premium that may make it more costly than money market hedge and forward hedge. If Baker has any doubt on whether the payment from Novo will actually be collected at agreed date, he may consider to use this foreign exchange option. With this foreign exchange option, if the value of Brazilian Reais goes down in future, Baker will be protected from the loss. Whereas, if the value of the Brazilian Reais goes up, Baker may give up the option and choose to exchange the Brazilian Reais on the spot exchange rate to gain more dollars than originally