education

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 […]

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

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

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,

What is the expected spot rate for September? Solution. The expected future spot rate is 1.80(0.15) + 1.85(0.2) + 1.90(0.25) + 1.95(0.20) + 2.00(0.20) = $1.905. Place Your Order Here!

Cost of the Basic Hedging Techniques Application Selective Hedging In March, Multinational Industries, Inc. (MII) assessed the September spot rate for sterling at the following rates: $1.80/£ with probability 0.15 $1.85/£ with probability 0.20 $1.90/£ with probability 0.25 $1.95/£ with probability 0.20 $2.00/£ with probability 0.20 a. What is the expected spot rate for September?

Benefits of Hedging. A company can benefit from the preceding techniques only to the extent that it can forecast future exchange rates more accurately than the general market. For example, if the company has a foreign currency cash inflow, it would hedge only if the forward rate exceeds its estimate of the future spot rate.

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.

Costs of Hedging. If a devaluation is unlikely, hedging may be a costly and inefficient way of doing business. If a devaluation is expected, the cost of using the techniques (like the cost of local borrowing) rises to reflect the anticipated devaluation. Just before the August 1982 peso devaluation, for example, every company in Mexico

Costs and Benefits of Standard Hedging Techniques Standard techniques for responding to anticipated currency changes are summarized in Exhibit 10.3. Such techniques, however, are vastly overrated in terms of their ability to minimize hedging costs. Place Your Order Here!