Measuring and managing exchange rate exposure L10 Flashcards
1
Q
Hedging techniques
A
- Forward or futures hedge
- Money market hedge
- Currency option hedge
2
Q
Money market hedge
A
- taking a money market position to cover a future payment/receipt.
- e.g., to hedge against a future foreign payment a firm can borrow funds in the home currency and Invest in the foreign currency earning interest until the payment matures
3
Q
Currency option hedge
A
- provides the right to buy/sell a specified amount of a particular currency at a specified strike price within a given period of time
4
Q
Forward or futures hedge
A
- using a forward contract to lock in the value of a future payment/receipt
5
Q
Arguments against hedging
A
- Hedging-as-Irrelevant (Modigliani and Miller)
- Hedging is costly
6
Q
Arguments for hedging
A
- Lowers exchange rate risk
- Improves investment decisions
- Can reduce firm’s expected taxes
7
Q
Hedging-as-Irrelevant - Modigliani and Miller
A
- It only changes non-systematic risk, no effect on firm’s value
- Investors can hedge on their own – equity positions
- Relies on “Perfect Markets” story
8
Q
Hedging is costly
A
- Bid-ask spread: larger in forward market
- Salaries and monitoring costs to evaluate hedging alternatives
9
Q
The real exchange rate risk of a net exporter
A
A competitive dilemma:
- Raise prices: lose market share
- Lower prices: lose profits
10
Q
Major factor that determines a firm’s response to exchange rate changes
A
- Price elasticity of demand for its product
11
Q
(Pro-hedging) Improves investment decisions
A
- Provides definite stream of income to finance investment
- Otherwise + NPV projects may be missed
12
Q
Can reduce firm’s expected taxes
A
- stable income =>
- predictable tax environment
- maximise tax benefits through strategic income management
- reduced risk of high taxes/penalties from income volatility
13
Q
Alternative Hedging techniques
A
- Leading and Lagging
- Cross-Hedging
- Currency Diversification
14
Q
Leading and Lagging
A
- Adjusting the timing of a payment or disbursement to reflect expectations about future currency movements
15
Q
Cross-Hedging
A
Hedging by using a proxy currency for the currency in which the MNC is exposed
16
Q
Currency Diversification
A
Reducing exposure by diversifying business across numerous countries
17
Q
Evidence on Firm’s Hedging Behaviour
A
- Large R&D firms hedge
- Highly levered firms hedge
- Firms with higher dividend yields hedge
- Hedging more common in large firms
-Firms with greater growth opportunities more likely to use derivatives - Some evidence to suggest hedging increases firm value
