FNCE 4103 Week 5 Transaction Exposure Memo Example

Memorandum

To: Chief Financial Officer, Lakeland Process Equipment

From: Treasury Analyst

Date: April 7, 2026

Re: Transaction exposure on the Rhein-Pumpen payable

The Contract

Counterparty: Rhein-Pumpen GmbH, a composite German pump maker. Amount: €2,000,000. Invoice currency: euros. Settlement date: July 6, 2026, 90 days after signing. Spot rate on the signing date: $1.0850 per euro, midmarket, from our bank's quotation. At signing, the payable was worth $2,170,000. Lakeland's revenue is entirely in U.S. dollars, so the full dollar cost of the payable is exposed to the exchange rate until we pay.

Dollar Cost at Several Rates

Table 1

Dollar Cost of the €2,000,000 Payable at Five Exchange Rates

Composite company and supplier; rates illustrative. A 5 percent move over 90 days is within the range the euro has moved in many recent quarters.

The Exposure

Between a 5 percent fall and a 5 percent rise in the euro, the dollar cost of this one payable ranges from about $2.06 million to about $2.28 million, a swing of $217,000. A 5 percent move in either direction over three months is not extreme for the euro against the dollar. The production line these pumps are for carries a planned margin of about $300,000, so an adverse move of this size would remove more than a third of it. The exposure has already moved against us by $14,000 in the week since signing (Madura, 2021).

What Kind of Exposure This Is

This is transaction exposure: a contractual cash flow in a foreign currency with a known amount and date. It is the easiest kind of currency exposure to measure and to hedge, because both the amount and the timing are fixed. Shapiro and Hanouna (2019) note that transaction exposures on known payables are the ones most firms hedge, even firms that leave longer-term exposures open.

Why Not Wait

The case for waiting is that the euro might fall and the payable become cheaper. That is true, but it is a bet, and Lakeland has no edge in making it. Our sales contract for the production line was priced in dollars months ago, so we cannot raise the price if the euro rises. The supplier will not wait for payment, and our bank line is already partly drawn for working capital. A loss of $100,000 or more on this payable would also arrive at the same time as other euro payments due to the supplier later in the year, which could be affected by the same move. Waiting therefore concentrates risk rather than spreading it. The cost of hedging now, by contrast, is small and known: the forward rate is only $8,000 above signing-day spot on the full amount, reflecting the interest rate difference rather than a fee.

Recommendation

Hedge at least 75 percent of the payable, €1,500,000, now. At the current forward rate that locks in $1,633,500 of the cost. Leaving 25 percent open preserves some benefit if the euro falls, while limiting the worst-case loss on the open portion to about $27,000 for a 5 percent rise. The choice between a forward contract, a money market hedge and a currency option is set out in a separate comparison; all three are workable for an amount of this size. Hedging the payable does not reflect a view on where the euro is going. It reflects the fact that Lakeland earns dollars, cannot pass a sudden cost increase to customers already under contract and would rather know its cost now (Bartram et al., 2010).

References

Bartram, S. M., Brown, G. W., & Minton, B. A. (2010). Resolving the exposure puzzle: The many facets of exchange rate exposure. Journal of Financial Economics, 95(2), 148-173. https://doi.org/10.1016/j.jfineco.2009.09.002

Madura, J. (2021). International financial management (14th ed.). Cengage Learning.

Shapiro, A. C., & Hanouna, P. (2019). Multinational financial management (11th ed.). Wiley.