Since you had sold forward DM 100,000, you must deliver them.
To do so, you must
go and buy them on the spot market, where you will face a spot rate which can be anything.
the other hand, suppose that you had netted out the cash-ins and cash-outs, and hedged the
remainder, i.e., bought only DM 40,000 forward.
If your debtor defaults, then in this case on 03-
15 you do not have the DM 100,000 that you were hoping to use to pay your creditor.
you must get them on the spot market, at a rate that again can be anything.
regardless of your netting, you face the same risk when you use forward or futures.
The bottom line of the previous paragraph is that
the only cost-effective way to
eliminate all foreign-exchange risk here is to use options for the hedging of cash-ins, and
buying forward or futures contracts for the hedging of cash-outs.
If your company thinks its debtors are safe credit risks, then you should recommend
same-currency netting and the hedging of the remainder with forwards/futures.
The netting out
of DM cash-outs against DG cash-ins is also pretty riskless, and may be safely made.
The use of
mismatched futures, though, should be discouraged.
THE MATERIAL IN PART C. BELOW IS DOES NOT CONSTITUTE EXAM
MATERIAL; IT IS PRESENTED SOLELY TO ILLUSTRATE THE PRACTICES OF
Suppose that your company is more interested in minimizing hedging costs than hedging.
What could you recommend? What risks would the company be exposed to?