Hedging Currency Risk at Duke Power
Randall R. Kincaid & Timothy E. Burson
Queens University of Charlotte
The main objective of this case is to illustrate one of the central problems of international business, dealing with exchange rate risk. A further objective is to demonstrate to the student the merits of the various hedging opportunities faced by Duke Power. The key issues are those faced by firms involved in international transactions: realizing the need to reduce their risk level, identifying available methods to reduce that risk, and selecting the vehicle that will best reduce risk while conforming to the firm’s basic position on risk.
The case can be used in an undergraduate international business or economics course, and has also been used in an MBA course with an emphasis on macroeconomics.
Duke Power, an electric generating and distributing company serving portions of North and South Carolina, had been a pioneer in the production of nuclear power. Duke Power needed replacement steam generator tubes for three of its nuclear generating units, and selected Sumitomo Corporation in Japan to manufacture the tubes. Sumitomo was one of the few corporations in the world capable of producing specialty high strength replacement tubes. The exchange rate between the dollar and the yen would float up and down with supply and demand forces over the delivery period. Because the value of the yen floated, and because the contract between Duke Power and Sumitomo was priced in yen, Duke faced considerable transaction risk.
Duke Power did have the opportunity to reduce its transaction risk by hedging its position in the foreign exchange (FX) market. FX market financial instruments have become a common tool for businesses involved in foreign trade. Once Duke Power made the decision to hedge its transaction risk, it needed to address the questions of when in the transaction to enter a hedging contract, and, then, what hedging vehicle to utilize.
This case was prepared by Randall Kincaid and Tim Burson, Queens University of Charlotte, and is intended to be used for class discussion rather than to illustrate either effective or ineffective handling of the situation.
Presented to and accepted by the North American Case Research Association (NACRA) for its annual meeting, November 2003, Tampa, Florida. All rights reserved to the authors and NACRA. © 2003 by Randall Kincaid and Tim Burson.