BMW, the German luxury car manufacturer, faced a significant challenge in 2007 when the value of the US dollar declined significantly against the euro. This presented a problem for BMW, as the company exports a large number of cars from Germany to the United States and receives payment in US dollars. With the decline in the value of the dollar, BMW's profits from these exports were being eroded.
To address this problem, BMW implemented a currency hedging strategy. This involved entering into financial contracts, such as forwards and options, to protect against fluctuations in exchange rates. By locking in a specific exchange rate for a future date, BMW was able to mitigate the impact of currency fluctuations on its profits.
One of the key elements of BMW's currency hedging strategy was the use of currency options. These are financial instruments that give the holder the right, but not the obligation, to buy or sell a specific currency at a predetermined exchange rate on a future date. BMW used currency options to protect against the possibility of the US dollar declining further against the euro.
In addition to currency options, BMW also used other financial instruments, such as forwards and swaps, to hedge its currency risk. A forward is a contract to buy or sell a specific currency at a predetermined exchange rate on a future date. A swap is a contract in which two parties agree to exchange a series of payments in different currencies. By using a combination of these financial instruments, BMW was able to effectively manage its currency risk.
Overall, BMW's currency hedging strategy proved to be successful in mitigating the impact of the declining value of the US dollar on the company's profits. By using a variety of financial instruments, BMW was able to protect itself against currency fluctuations and maintain a stable stream of revenue from its exports to the United States.