1.a. By using the forward foreign exchange market, Jaguar can reduce its foreign exchange rate risk through the use of arbitrage and hedging. Arbitrage and hedging situations occur with regularity among the several foreign exchange markets. Between any two national currencies, there is an exchange rate. In a system where individuals may trade foreign currencies, arbitrage insures that a sequence of transactions starting in one currency and continuing on through several other currencies will result in the same quantity of the starting currency less transactions costs. As an example, trading Canadian dollars for French francs, French francs for Japanese yen, and Japanese yen for Canadian States dollars results in a final quantity of Canadian dollars equal to the initial quantity of Canadian dollars less the transactions costs, as a result of arbitrage. Arbitrage is used by the financial officers of multinational business organizations, such as Jaguar, for the purpose of reducing risk.
In the context of the multinational business organization, potential foreign exchange losses depend on a company's exposure on its vulnerability to foreign exchange loss. In a general sense, there are two main types of such exposure commercial exposure and translation exposure. Commercial exposure arises when a company has an obligation to make or to receive payment in a foreign currency, such as the payment for imported goods or the collection for exported products. In the case of imports, losses could occur, if the value of
the foreign currency were to rise in relation to the home country currency of the importer. In the case of exports, losses could occur, if the value of the foreign currency were to be devalued in relation to the home currency of the exporter. In such instances, the multinational business organization may enter a forward market for foreign currencies, and apply the concept of arbitrage to limit the risks associate...