FMS- hedging strategies and using derivatives

Question 1

hedging

Answer 1

The process of minimising risks in currency transactions

NATURAL HEDGING STRATEGIES  a number of naturally occurring strategies to eliminate or minimise the risk of foreign exchange exposure

DERIVATIVES  a set of artificial yet simple financial instruments that may be used to lessen the exporting risks associated with currency fluctuations

Question 2

natural hedging strategies

Answer 2

Global businesses can naturally mitigate the risk of currency fluctuations by:

Establishing offshore subsidiaries within chosen country (no need to change currency
OR
Arranging for import payments and export recipients in the same foreign currency or Australian dollars

Question 3

what does Mcdonalds do?

Answer 3

“while changes in foreign currency exchange rates affect reported results, McDonalds mitigates exposures, where practical, by purchasing goods and services in local currencies, financing in local currencies and hedging certain foreign-denominated cash flows
McDonalds corporation annual report 2018 p20

Question 4

Derivatives

Answer 4

Derivatives represent artificial financial instruments that act to distort the real value of currency in the foreign exchange market. Businesses will negotiate ways of exchange market

Businesses will negotiate ways of controlling the currency rates to favour their needs

Such derivatives include

1. Forward exchange contracts
2. Options contract
3. Currency swap contracts

Question 5

forward exchange contracts

Answer 5

a contract to exchange ne currency for another currency at an agreed exchange rate on a future date rather than the future spot price
This period is usually 30, 90 or 180 days

Question 6

options contract

Answer 6

gives the buyer the right, but not the obligation, to buy or sell foreign currency at EITHER the current price or spot price (if more favourable) at some time in the future

Option holders are protected from unfavourable exchange rate fluctuations, yet maintain the opportunity for gain should exchange rate movements be favourable

Question 7

currency swap contracts

Answer 7

currency swap is an agreement to exchange currency in the spot market with an agreement to reverse the transaction in the future

it involves a spot sale of one currency together with a forward repurchase of the currency at a specified date in the future