Basic Hedging Techniques
Reducing the level of cash holdings to lower exposure can adversely affect a subsidiary’s operations, whereas selling LC-denominated marketable securities can entail an opportunity cost (the lower interest rate on hard currency securities). A firm with excess cash or marketable securities should reduce its holdings regardless of whether a devaluation is anticipated. After cash balances are at the minimum level, however, any further reductions will involve real costs that must be weighed against the expected benefits.
Invoicing exports in the foreign currency and imports in the local currency may cause the loss of valuable sales or may reduce a firm’s ability to extract concessions on import prices. Similarly, tightening credit may reduce profits more than costs.
In summary, hedging exchange risk costs money and should be scrutinized like any other purchase of insurance. The costs of these hedging techniques are summarized in Exhibit 10.4.