Question

1.) Explain the concept of mismatched maturities? Give an example. What is the purpose of this technique?

2.) What is a Balance Sheet hedge? Why would a firm use one?

Please help me answer these international financial management questions. Thank you!

Answer 1

Mismatched maturities is a concept where assets held to meet future liabilities (for example: loan payments) are not properly aligned in terms of the maturity times.

For example: company has made FDs with maturity of 5 years and non premature withdrawal. After 2 years, company has to make a liability payment which can be bank loan payments or trade payable. Since in this case, despite company has money due to mismatch in maturity, company might face liquidity issue. Purpose of the technique is to exactly match the cashflows from assets in future to meet liabilities.

Balance sheet hedging is a concept where company which is exposed to foreign currency fluctuations would have impact on few components on balance sheet. Company would enter into hedging concept in the form of booking forwards or options fo reduce the fluctuations. This would reduce risk to the company thereby protecting the interest of the company.

For example: Loan availed in foreign currency. Loan payments every month has to be made in foreign currency. Due to fluctuations in currency, company might have to pay high loan due to conversion costs. Hence hedging is important.