hedging essays

hedging essays Currency and Hedging As business becomes increasingly global more and more firms find it necessary to pay careful attention to foreign exchange exposure and to design and implement appropriate hedging strategies. Exchange rate risk is the unexpected exchange rate changes creating variability in the domestic currency value of current and future cash flows of a company. Foreign exchange risk management begins by identifying what items and amounts a firm has exposed to risk associated with changes in exchange rates. Exchange rate risk thus depends upon how "volatile" exchange rates are and the size of the "exposure" to exchange rate changes meaning the amount of cash flows whose domestic currency value is sensitive to exchange rate changes. Foreign exchange exposure is usually categorized according to whether it falls into one or more of the following categories, for example there are transaction exposure, economic exposure and translation exposure. Transaction exposure is concerned with how changes in exchange rates affect the value of anticipated foreign currency denominated cash flows relating to transactions already entered into. By failing to cover transaction exposure, a firm may incur a vast loss on a single very large receivable or payable denominated in a foreign currency. This may result in an overall loss for the firm in a particular financial period which could in its turn, lead to financial distress. Economic exposure refers to the possibility that the present value of future operating cash flows of a business, expressed in home currency, may be affected by a change in foreign exchange rates. According to purchasing power parity theory, exchange rate changes are associated with different relative rates of inflation. Translation or accounting exposure arises as a result of the process of consolidation of foreign currency items into group financial statements denominate ...