Mncs and Hedging Technique

MNCs will normally compare the cash flows that could be expected from each hedging technique before determining which technique to apply. A futures hedge involves the use of currency futures. To hedge future payables, the firm may purchase a currency futures contract for the currency that it will be required. A forward hedge differs from a futures hedge in that forward contracts are used instead of futures contract to lock in the future exchange rate at which the firm will buy or sell a currency .An exposure to exchange rate movements need not necessarily be hedged, despite the ease of futures and forward hedging. Based on the firm’s degree of risk aversion, the hedge-versus-no-hedge decision can be made by comparing the known result of hedging to the possible results of remaining un-hedged. If the real cost of hedging is negative, then hedging is more favorable than not hedging. To compute the expected value of the real cost of hedging, first develop a probability distribution for the future spot rate, and then use it to develop a probability distribution for the real cost of hedging. If the forward rate is an accurate predictor of the future spot rate, the real cost of hedging will be zero. If the forward rate is an unbiased predictor of the future spot rate, the real cost of hedging will be zero on average. A money market hedge involves taking one or more money market position to cover a transaction exposure. The identified results of money market hedging can be compared with the results of forward or futures hedging to determine the type of hedging that is preferable. A currency option hedge involves the use of currency call or put options to hedge transaction exposure. A comparison of hedging techniques should focus on minimizing payables, or maximizing receivables and the cash flows associated with currency option hedging and remaining un-hedged cannot be determined with certainty. Generally hedging policies vary with the MNC management’s degree of risk

References: The Free Dictionary by Farlex, Transaction Exposure, from website http://financial-dictionary.thefreedictionary.com/Transaction+Exposure Munene Laiboni, Mathematical Finance, HEDGING EXCHANGE RATE RISK: MANAGEMENT OF TRANSACTION EXPOSURE, http://laiboni.wordpress.com/2012/06/20/hedging-exchange-rate-risk-management-of-transaction-exposure/ McGraw-Hill, Management of Transaction Exposure: http://highered.mcgraw-hill.com/sites/dl/free/0070912289/235906/new_chapter_13.pdf