Trunk Road Corporation, a global manufacturing company faced significant exposure to commodity price volatility due to its reliance on raw materials for production. To address this challenge, how can Trunk Road Corporation mitigate the impact of commodity price fluctuations, and enhance financial flexibility by using derivatives strategically:
Trunk
Road Corporation can mitigate the commodity price volatility and enhance
financial flexibility using derivatives strategically:
Mitigating
Price Volatility:
·
Hedging
with futures contracts: Trunk
Road Corporation can enter into futures contracts to lock in a price for their
raw materials at a specific future date. This protects them from price increases
above the agreed-upon price.
·
Put
Options: Purchasing put options
allows Trunk Road Corporation to set a minimum price for their raw materials.
If the price falls below the strike price, they can exercise the option and
sell the raw materials at the guaranteed price, limiting potential losses.
Enhancing
Financial Flexibility:
·
Interest rate
swaps: If Trunk Road Corporation has variable-rate debt, they can use interest
rate swaps to convert it to fixed-rate debt. This provides predictability in their
financial costs and protects them from rising interest rates.
·
Currency swaps: If
Trunk Road Corporation purchases raw materials in a foreign currency, they can
use currency swaps to lock in an exchange rate. This safeguards them from adverse
currency fluctuations that could increase their material costs.
By
implementing a combination
of these strategies, Trunk Road Corporation can mitigate the financial risk
associated with commodity price volatility and interest rate fluctuations. This
allows for more predictable costs, improved cash flow management, and ultimately,
greater financial flexibility.