Answer. A company such as Cost Plus will typically negotiate purchase contracts with the suppliers of its catalogue merchandise in advance. Cost Plus could hedge these purchases using forward contracts. A problem, though, is that if the foreign currencies devalue during the life of the catalogue, prices of substitute products for the items in the catalogue will likely come down somewhat. In this case, some customers who might have bought from Cost Plus will decide to buy the cheaper substitutes, costing Cost Plus sales. This is very likely here given the nature of Cost-Plus products: low‑cost goods presumably bought by a price‑sensitive clientele.

The existence of quantity risk in addition to price risk suggests that Cost Plus should hedge less than 100% of its projected sales. As an alternative, Cost Plus could buy call options to cover its foreign purchases. If the foreign currencies drop below the call option price, the firm won’t exercise its options; if they rise above the call price, Cost Plus will exercise them.