Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Chapter 11
Managing Transaction Exposure
Lecture Outline
Policies for Hedging Transaction Exposure
Hedging Most of the Exposure
Selective Hedging
Hedging Payables
Forward or Futures Hedge
Money Market Hedge
Call Option Hedge
Comparison of Techniques Used to Hedge Payables
Evaluating the Hedge Decision
Hedging Receivables
Forward or Futures Hedge
Money Market Hedge
Put Option Hedge
Comparison of Techniques for Hedging Receivables
Evaluating the Hedge Decision
Summary of Hedging Techniques
Limitations of Hedging
Limitation of Hedging an Uncertain Amount
Limitation of Repeated Short-term Hedging
Alternative Hedging Techniques
Leading and Lagging
Cross-Hedging
Currency Diversification
Chapter Theme
A primary objective of the chapter is to provide an overview of hedging techniques. Yet, transaction
exposure cannot always be hedged in all cases. Even when it can be hedged, the firm must decide
whether a hedge is feasible. While a firm will only know for sure whether hedging is worthwhile after the
period of concern, it can incorporate its expectations about future exchange rates, future inflows and
outflows, as well as its degree of risk aversion to make hedging decisions.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Managing Transaction Exposure 2
Topics to Stimulate Class Discussion
1. Is transaction exposure relevant?
2. Why should a firm bother identifying net transaction exposure?
3. Should management of transaction exposure be conducted at the subsidiary level or at the centralized
level? Why?
4. Assume that you decided to hedge future payables of 1 million Swiss francs using the forward hedge.
Go through the specific steps required for you to use the forward hedge of 1 million francs.
5. Assume that you decided to hedge future receivables of 1 million Canadian dollars using currency
options. Go through the specific steps required for you to use currency options to hedge this position.
POINT/COUNTER-POINT:
Should an MNC Risk Overhedging?
POINT: Yes. MNCs have some “unanticipated” transactions that occur without any advance notice. They
should attempt to forecast the net cash flows in each currency due to unanticipated transactions based on
the previous net cash flows for that currency in a previous period. Even though it would be impossible to
forecast the volume of these unanticipated transactions per day, it may be possible to forecast the volume
on a monthly basis. For example, if an MNC has net cash flows between 3,000,000 and 4,000,000
Philippine pesos every month, it may presume that it will receive at least 3,000,000 pesos in each of the
next few months unless conditions change. Thus, it can hedge a position of 3,000,0000 in pesos by selling
that amount of pesos forward or buying put options on that amount of pesos. Any amount of net cash
flows beyond 3,000,000 pesos will not be hedged, but at least the MNC was able to hedge the minimum
expected net cash flows.
COUNTER-POINT: No. MNCs should not hedge unanticipated transactions. When they overhedge the
expected net cash flows in a foreign currency, they are still exposed to exchange rate risk. If they sell
more currency as a result of forward contracts than their net cash flows, they will be adversely affected by
an increase in the value of the currency. Their initial reasons for hedging were to protect against the
weakness of the currency, but the overhedging described here would cause a shift in their exposure.
Overhedging does not insulate an MNC against exchange rate risk. It just changes the means by which the
MNC is exposed.
WHO IS CORRECT? Use the Internet to learn more about this issue. Offer your own opinion on this
issue.
ANSWER: If the MNC is confident that it will receive net cash flows in a currency that will likely
depreciate, it should hedge at least the minimum amount of cash flows to be received. If it overhedges,
and the currency’s spot rate declines below the forward rate that was negotiated at the time of the hedge,
the MNC may even benefit from the overhedged position. The MNC should try to avoid overhedging the
net cash flows of a currency that it would expect to strengthen. It may be better off by hedging a smaller
amount or not hedging at all.
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Managing Transaction Exposure 3
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
