Basic Strategy for Hedging Translation Exposure Funds adjustment involves altering either the amounts or the currencies (or both) of the planned cash flows of the parent or its subsidiaries to reduce the firm’s local currency accounting exposure. If an LC devaluation is anticipated, direct funds adjustment methods include pricing exports in hard currencies and imports […]
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Managing Translation Exposure Firms have three available methods for managing their translation exposure: (1) adjusting fund flows, (2) entering into forward contracts, and (3) exposure netting. The basic hedging strategy for reducing translation exposure shown in Exhibit 10.5 uses these methods. Essentially, the strategy involves increasing hard currency (likely to appreciate) assets and decreasing soft
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Three points are worth noting. Hedge designations are critical. Each hedging relationship should fit into the company’s risk management objectives and strategy, which must be documented. Hedging must be effective. To qualify for hedge accounting, an entity must demonstrate a hedging relationship to be highly effective in achieving offsetting changes in fair value or cash
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Accounting for Hedging and FASB 133 Companies have a greater incentive for systematizing their hedging practices since FASB issued its Statement of Financial Accounting Standards No. 133 (FASB 133) to establish accounting and reporting standards for derivative instruments and for hedging activities. Under FASB 133, a foreign currency derivative that qualifies as a foreign currency
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Application The Luck of the Irish Eludes Allied Irish Banks In February 2002, Allied Irish Banks announced that a rogue trader at its U.S. unit lost $750 million through unauthorized foreign exchange trades. Allied said John Rusnak, a foreign exchange dealer at its U.S. unit Allfirst tried to disguise huge losses through fictitious foreign exchange
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Managing Risk Management A number of highly publicized cases of derivatives-related losses have highlighted the potential dangers in the use of derivatives such as futures and options. Although not all these losses involved the use of currency derivatives, several lessons for risk management can be drawn from these cases, which include the bankruptcies of Orange
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Centralization versus Decentralization In the area of foreign exchange risk management, there are good arguments both for and against centralization. Favoring centralization is the reasonable assumption that local treasurers want to optimize their own financial and exposure positions, regardless of the overall corporate situation. An example is a multibillion-dollar U.S. consumer-goods firm that gives its
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Exposure Netting. Exposure netting involves offsetting exposures in one currency with exposures in the same or another currency, where exchange rates are expected to move in a way such that losses (gains) on the first exposed position will be offset by gains (losses) on the second currency exposure. This portfolio approach to hedging recognizes that
What factors are likely to affect Multinational Industries’ hedging decision? Solution. Risk aversion could lead MII to sell its receivables forward to hedge their dollar value. However, if MII has pound liabilities, they could provide a natural hedge and reduce (or eliminate) the amount necessary to hedge. The existence of a cheaper hedging alternative, such
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If the six-month forward rate is $1.90, should the firm sell forward its £500,000 pound receivables due in September? Solution. If MII sells its pound proceeds forward, it will lock in a value of $950,000 (1.90 × 500,000). Alternatively, if it decides to wait until September and sell its pound proceeds in the spot market,