Gaining a better understanding of derivative securities with regard to hedging opportunities is essential in today’s financially-driven market. Financial derivative securities are used by many businesses to protect against risks or to profit from them. A company interested in protecting against the risk of some event would be engaging in hedging activities while one seeking to profit from a future event would be speculating (Eiteman, Stonehill, & Moffett, 2010).
Hedging and speculation activities can be used against various types of risks faced by companies including those associated with interest rates, costs of commodities, and currency exchanges. Bartram, Brown, and Conrad (2011) discovered firms can also significantly reduce various types of risk, such as “cash flow risk, total risk, and systematic risk” (p. 973) through the use of derivatives. Although numerous risks can be hedged with financial derivatives, this paper will focus on the reduction of exchange rate risks through hedging activities.
There are several types of derivatives that can be used to hedge exchange rate risk. Júnior (2011) noted that exchange rate movements can be reduced through the use of hedging instruments like swaps, futures, forwards, and options. An assessment of each type of derivative instrument will be discussed in the following sections of this paper. The paper will conclude with an assessment of which approach to hedging with derivatives is optimal.
A foreign currency futures contract is a standardized contract which outlines the time, place, and price of a future fixed amount of foreign exchange (Eiteman et al., 2010). The contract terms are standardized based on the requirements of the exchange where the futures contract is tr...
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... foreign exchange risk is to evaluate the level of risks faced and create an approach to address it that’s in line with the company’s goals.
Works Cited
Bartram, S. M., Brown, G. W., & Conrad, J. (2011). The effects of derivatives on firm risk and value. Journal of Financial & Quantitative Analysis, 46(4), 967-999. http://dx.doi.org/10.1017/S0022109011000275
Eiteman, D. K., Stonehill, A. I., & Moffett, M. H. (2010). Multinational Business Finance. (12th ed.). Boston, MA: Pearson Education, Inc.
Júnior, J. (2011). Exchange Rate Exposure, Foreign Currency Debt, and the Use of Derivatives: Evidence from Brazil. Emerging Markets Finance & Trade, 47(1), 67-89. http://dx.doi.org/10.2753/REE1540-496X470104
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Forex is an abbreviated name for foreign exchange. The Forex trading market is an around-the-clock cash market where the currencies of nations are bought and sold, typically via brokers. For example, you buy Euros, paying with U.S. Dollars, or you sell Canadian Dollars for Japanese Yen. Forex trading market conditions can change at any moment in response to real-time events, such as political unrest or the rate of inflation. The purpose of this article is to give you an introduction to Forex trading.
Caterpillar Inc. also faces the risk of its cash flow and earnings being affected by fluctuations in the exchange rates of currency, commodity prices, and interest rates. To control for this, the company’s Risk Management Policy ensures prudent management of interest rates, commodity prices, and exchange rates of foreign currency by allowing the use of derivative financial instruments. According to the policy, the derivative financial instruments are not supposed to be used for the purpose of speculation. In its pricing strategy, Caterpillar Inc. faces the risk of difficult shipping of its products. This risk can be encountered by offering its products on instalments and lease to its loyal customers (Caterpillar, Inc. (CAT), 2011).
Hennart, J-F (2001) Theories of the Multinational Enterprise, In Rugman A. M. and T. L. Brewer (eds.) (2001) The Oxford Handbook of International Business, OUP, Oxford
1. What is the business reason for China Noah’s potential currency exposure? Does the company need to subject itself to substantial exchange rate risk? Is the risk “material” to China Noah? Do you think China Noah should hedge?
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Finance theory does not provide a complete framework for explaining risk management under the fluctuated financial environment in which firm operates. Hence, for corporate managers, they rank risk management as one of their top priorities. One of the strategies to reduce risk is by hedging. This paper will discuss the advantages and disadvantages of hedging risk using financial derivatives.
After completing my graduate degree, working as a financial consultant in a multinational enterprise is my dream striving to come true. Endless conflicts with partners, continual misunderstandings with clients, and mutual distrust between parent company and subsidiaries would often happen in multinationals.
Multinational enterprise (MNE) is “a company that is headquartered in one country but has operations in one or more other countries” (Rugman and Collinson 2012, p.38) that has at least one office in different countries but centralised home office. These offices coordinate global management in the context of international business. MNEs have increasingly essential influence on the development of the global economy and coordinate with other companies in different business environments. However, there are many issues involved with how MNEs operate well overseas, especially in emerging markets (EMs) (Cavusgil et al., 2013, p.5).
Other types of exchange rate risks are translation risk and so-called hidden risk. The translation risk relates to cases where large multinational companies have subsidiaries in other countries. On the financial statement of the whole group, the company may have to translate the assets and liabilities from foreign accounts into the group statement. The translation will involve foreign exchange exposure. The term hidden risk evolves around the fact that all companies are subject to exchange rate risks, even if they don’t do business with companies using other currencies. A company that is buying supplies from a local manufacturer might be affected of fluctuating foreign exchange rates if the local manufacturer is doing business with overseas companies. If a manufacturer goes out of business, or experience heavy losses, it will affect all the companies it does business with. The co...
The stability of currency values plays a significant role for economic and financial stability. It is not difficult to see the exchange rate fluctuations are widely regarded as damaging. As the movements of the exchange rate have significant and large effects on the trade balance, resource allocation, domestic prices, interest rate, national income and other key economic variables. Then can exchange rate movements be predicted by these fundamental economic variables?
...ting in hedging activities in the financial futures market companies are able to reduce the future risk of rising interest rates. By participating in the financial futures market companies are able to trade financial instruments now for a future date (Block & Hirt, 2005).
The foreign exchange market is one of important mechanism in the international business because foreign exchange is an intermediary for all nations in term of the growth of the economy. There are many functions of foreign exchange market in the global economy. In the international business, it uses the foreign exchange markets in four ways. First, the pay...