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Lecture International financial management - Chapter 11: Managing transaction exposure

In this chapter, you will learn: Compare the techniques commonly used to hedge payables, compare the techniques commonly used to hedge receivables, describe limitations of hedging, suggest other methods of reducing exchange rate risk when hedging techniques are not available. | 1 1 2 11 Managing Transaction Exposure Compare the techniques commonly used to hedge payables Compare the techniques commonly used to hedge receivables Describe limitations of hedging Suggest other methods of reducing exchange rate risk when hedging techniques are not available 2 Chapter Objectives 2 3 Policies for Hedging Transaction Exposure Hedging Most of the Exposure Hedging most of the transaction exposure allows MNCs to more accurately forecast future cash flows (in their home currency) so that they can make better decisions regarding the amount of financing they will need. Selective Hedging MNC must identify its degree of transaction exposure. MNC must consider the various techniques to hedge the exposure so that it can decide which hedging technique is optimal and whether to hedge its transaction exposure. 4 Hedging Exposure to Payables An MNC may decide to hedge part or all of its known payables transactions using: Futures hedge Forward hedge Money market hedge Currency option hedge 5 Forward or Futures Hedge on Payables Allows an MNC to lock in a specific exchange rate at which it can purchase a currency and hedge payables. A forward contract is negotiated between the firm and a financial institution. The contract will specify the: currency that the firm will pay currency that the firm will receive amount of currency to be received by the firm rate at which the MNC will exchange currencies (called the forward rate) future date at which the exchange of currencies will occur 6 Money Market Hedge on Payables Involves taking a money market position to cover a future payables position. If a firm prefers to hedge payables without using its cash balances, then it must Borrow funds in the home currency and Invest in a short-term instrument in the foreign currency 7 Call Option Hedge on Payables A currency call option provides the right to buy a specified amount of a particular currency at a specified strike price or exercise price within a given period of time. | 1 1 2 11 Managing Transaction Exposure Compare the techniques commonly used to hedge payables Compare the techniques commonly used to hedge receivables Describe limitations of hedging Suggest other methods of reducing exchange rate risk when hedging techniques are not available 2 Chapter Objectives 2 3 Policies for Hedging Transaction Exposure Hedging Most of the Exposure Hedging most of the transaction exposure allows MNCs to more accurately forecast future cash flows (in their home currency) so that they can make better decisions regarding the amount of financing they will need. Selective Hedging MNC must identify its degree of transaction exposure. MNC must consider the various techniques to hedge the exposure so that it can decide which hedging technique is optimal and whether to hedge its transaction exposure. 4 Hedging Exposure to Payables An MNC may decide to hedge part or all of its known payables transactions using: Futures hedge Forward hedge Money market hedge Currency .