Pixonix was based in Canada - its revenues were denominated in Canadian dollars while a significant portion of its expenses were to be paid in USD. Thus, Pixonix had to convert its Canadian dollar cash flows into US dollars annually. Canadian dollar was strengthening and cash flow and profitability had been impacted positively. Cain was in a dilemma about what would ...view middle of the document...
5 million for licensing proprietary tools and software through a US company. In other words, she was worried about the effect the volatility in CAD would have on the company’s cash flows.
Pixonix should hedge its USD position. In case if Pixonix does not hedge its USD liability, there is a possibility of it experiencing volatility in its cash flows. This could lead to two possible effects. First effect is that if CAD depreciates with respect to USD, Pixonix can make losses due to its unhedged currency exposure. On the other hand if CAD further appreciates with respect to USD (which is the more likely the case) then it will save on transaction costs of hedging and can benefit from the potential upside of CAD appreciation.
Buying currency options is a more flexible form of hedging than setting up a foreign exchange contract. The instrument allows limited risk as in the case of non exercise of an option you only loose the option premium. Although options provide Pixonix with the flexibility it also has some disadvantages.