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When a company has receipts and payments in the same foreign currency due at thesame time, it can use ___________technique of managing forex risk.

When a company has receipts and payments in the same foreign currency due at thesame time, it can use ___________technique of managing forex risk.

Looking for the answer to the question below related to Financial Management ?

When a company has receipts and payments in the same foreign currency due at thesame time, it can use ___________technique of managing forex risk.

 Options:

A. Risk Sharing Agreement
B. Lagging
C. Leading
D. Matching

The Correct Answer Is:

  • D. Matching

The correct answer is D. Matching.

Matching is a technique used by companies to manage foreign exchange (forex) risk when they have receipts and payments in the same foreign currency due at the same time. This technique involves aligning the timing of foreign currency inflows and outflows to minimize exposure to exchange rate fluctuations. Let’s delve into why Matching is the correct choice and why the other options are not as suitable.

Why Matching is the Correct Choice:

Matching is an effective strategy for managing forex risk because it seeks to eliminate or significantly reduce the exposure to exchange rate fluctuations by aligning foreign currency inflows and outflows. Here’s a detailed explanation of why Matching is the correct answer:

1. Risk Mitigation:

Matching ensures that the company’s foreign currency payments match its foreign currency receipts, essentially eliminating the risk associated with exchange rate fluctuations during that specific period. When the receipts and payments are in equilibrium, there is no net foreign exchange exposure, and the company is protected from adverse currency movements.

2. Cost Efficiency:

By matching currency inflows and outflows, a company avoids the need to engage in costly forex hedging instruments such as forward contracts or options. These instruments often come with fees and can be complex to implement, whereas Matching is a relatively straightforward and cost-effective approach.

3. Simplicity:

Matching is a simple and easy-to-implement strategy. Companies do not need to enter into complex agreements or negotiations, as they are merely aligning the timing of their transactions.

4. Cash Flow Management:

Matching also assists in cash flow management, as it ensures that funds in foreign currency are readily available to meet foreign currency obligations when they arise. This can be especially crucial for companies with international operations or trading partners.

5. Reduced Accounting Complexity:

Managing multiple forex transactions can lead to accounting complexity, including the need to mark-to-market or record unrealized gains and losses. With Matching, these complexities are minimized, as there is no net forex exposure.

Why the Other Options are Not Correct:

A. Risk Sharing Agreement:

Risk sharing agreements typically involve sharing forex risk with a third party, such as a financial institution. This approach may not be suitable when a company has equal amounts of receipts and payments in the same foreign currency due at the same time because there is no net risk to share. Risk sharing agreements are typically used when a company has an uneven distribution of forex risk.

B. Lagging:

Lagging is a strategy where a company delays its foreign currency payments or receipts to avoid exposure to adverse exchange rate movements. This strategy is used when a company believes that the currency will move in its favor. However, it does not address the scenario where receipts and payments are due simultaneously. Lagging could result in payment delays or missed opportunities.

C. Leading:

Leading involves accelerating foreign currency payments or receipts to take advantage of what the company believes will be favorable exchange rates in the future. Again, leading does not address the scenario where receipts and payments are due at the same time. Leading may expose the company to unnecessary forex risk if the anticipated exchange rate movement does not materialize.

In summary, when a company has receipts and payments in the same foreign currency due at the same time, the Matching technique is the most appropriate and effective way to manage forex risk. It ensures that the company is not exposed to exchange rate fluctuations during that specific period, is cost-efficient, and simplifies cash flow management and accounting processes.

The other options, such as Risk Sharing Agreement, Lagging, and Leading, are not suitable in this context because they do not directly address the scenario of simultaneous foreign currency inflows and outflows.

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