Better Food Corporation. Advantages of Forward Contracts: Price Protection & Minimal Cost - Paper Sample

There is minimal cost incurred to enter into the forward contract. The entrance of the Better Food Corporation into the forward contracts is advantageous since forward contracts provide hedges that are complete. The Better Food Corporation can match forward contracts against exposures of the period of time and the size of cash. Additionally, the utilization of forward contracts offers price protection. The Company can understand forward contracts with ease, which can also be written for any term or amount.

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Forward contracts, however, have their cancellation difficult to find counter-parties. On the due date, the Better Food Corporation will be obligated to its foreign currency for American dollars at the rate of forward contracts. The most danger related to forward contracts is that they are subject to default risk(s). The rate of future spot probably may or may not be beneficial to the Company due to the dynamic nature of foreign exchange rates. In contrast with the option contract, the back out ability must be bought or purchased. The Better Food Corporation, therefore, fails to be bound to exchange its foreign currency at a price that was previously determined.

As contrasted with the option contract, therefore, forward contracts are the most cost-effective for foreign exchanges’ related risks (Ianieri, 2020). The reason for this is the Better Food Corporation can tailor that forward contracts according to its underlying needs. Additionally, options contracts are most likely to be illiquid while they become worthless quickly. Sellers entering the option contracts are engaged with unlimited potential risks contrasted with buyers with limited risk potentials.

Currency risk management helps to stabilize cash flows while reducing its attached uncertainties. In the FX forward contracts, parties exchange designated currencies at a rate that was previously determined on a specific future date (Myforexeye, 2020). The contracts happen after the settlement of spot contracts. Equally, buyers are protected from currency price fluctuation. Forward contracts are difficult to withdraw while they remain binding to the buyers. The dynamic hedging allows businesses to readapt to their hedging positions to the market conditions at evolvement. Its accomplishment is to provide solutions that are flexible enough to protect investments from risks related to the foreign exchange rate (Sudacevschi, 2017). Therefore, the FX forward instrument is the best given the buyers’ situation about foreign currency exchange.

Conclusion

In conclusion, it is more advantageous for buyers to engage in forward contracts compared to option contracts. This is because forward contracts are tailor-made, and therefore, they can be made to fit all company needs. The option contracts deny buyers an opportunity to get obligated to make an exchange of foreign currency at a previously predetermined price. Besides, option contracts might at some point in time appear more advantageous, considering its increased potential returns and the provision of multiple alternative strategies. Since option lies with buyers who enter the FX option contract, the option contract protects them from risks that are downwards while they retain potentials in the upside at the event rates of exchange favorably change.

References

Ianieri, R., (2020). Four advantages of options. Retrieved on: 5/8/2020. https://www.investopedia.com/articles/optioninvestor/06/options4advantages.asp

Myforexeye, (2020). Management of Currency Exchange Risk during COVID-19. Retrieved on: 5/8/2020. https://www.myforexeye.com/fx-volatility-is-it-the-right-time-to-practice-dynamic-hedging

Sudacevschi, M. (2017). Foreign currency risk hedging. Challenges of the Knowledge Society, 742-746. Retrieved on: 5/8/2020. https://scholar.google.com/scholar?hl=en&as_sdt=0%2C5&as_ylo=2016&q=advantages+and+disadvantages+of+FX+forward+and+option+contracts&btnG=