Leo LLP is a company which sources materials internationally, and then sells these on nationally at a small margin. Leo LLP has noted that there is a risk of exchange rate fluctuations making their purchases unviable. The CFO has declared that the only way to mitigate this risk is via hedging and that they should look at price fixing. is this correct?

Leo LLP is a company which sources materials internationally, and then sells these on nationally at a small margin. Leo LLP has noted that there is a risk of exchange rate fluctuations making their purchases unviable. The CFO has declared that the only way to mitigate this risk is via hedging and that they should look at price fixing. is this correct?
A . yes- hedging is the only solution to mitigate the risk of adverse price movements
B. yes- this reduces the risk to 0
C. no- Leo LLP could do nothing and increase its prices instead
D. no- Leo LLP can take out insurance to mitigate this risk

View Answer

Answer: C

Explanation:

The correct answer is 3 ‘no Leo LLP could do nothing and increase its prices instead’. Firstly the CFO is wrong. There are other ways to mitigate this risk than hedging- hedging isn’t the ONLY thing you can do. Therefore you automatically need to discount options that begin with yes. Then looking at the options that begin with no, insurance isn’t going to help in this situtation. Therefore, by process of elimination you will be left with ‘no Leo LLP could do nothing and increase its prices instead’.

This question is taken from p.95 – there is a section here describing alternatives to hedging. When dealing with currency fluctuations, an alternative to fixing a price is to build in a margin on your own prices. This margin acts as a buffer for if prices go up- your price can remain the same. Other alternatives to hedging suggested by CIPS include; negotiating long term contracts, buying out the supplier and ingredient substitution