Explain how a firm can hedge its translation exposure and the limitations of hedging translation exposure.

Explain how a firm can hedge its translation exposure and the limitations of hedging translation exposure.

Expert Solution

Translation risk is the risk a company faces due to change in value of its asset, liabilites, equity while translating them into reporting currency. that means ths risk is faced by multinational companies which have operation or subsidiaries whose reporting currency is different from reporting currency of parent company. they have to face th risk of hange in exhange rate between two currencies.

A firm can hedge its translation exposure by purchasing foreign Currency or by currency Swap,Currency Option, Forward Contract or by combination of any of these.

Currency Swap: It is an agreement between two parties to exchange cash flow denminated in one currency for another over a predertermined perid. Currenc amount are swapped for a predetermined period against nterest paid for that period.

Currency Option: This gives the party ( who buys the option) an option not obligation to purchase the currency at particular rate. however this should be exrcised before a given date in future.

Forward COntract: under this two parties fix exchange rate for two specific currencies on a particular future date.

However as translation exposure is a non cash item. its just reporting losses /gain.As actual gian/loss arises only when company decides to sell the asset. so firm have to think strategically before adopting any hedging strategy to mitigate only notional currency loss. if firm go fo hedging transactioal loss it get exposed to actual gain/loss whereas transactional loss is just recording loss.

jeff jeffy answered 2 years ago

An Australian firm uses a forward contract to hedge all of its translation exposure. Assume that...

An Australian firm uses a forward contract to hedge all of its translation exposure. Assume that the firm overestimated what its foreign earnings would be and assume that the foreign currency appreciated over the year. The firm would generate a transaction loss.

Money market hedge can be used to hedge a firm’s translation exposure to exchange rate risk....

Money market hedge can be used to hedge a firm’s translation exposure to exchange rate risk. Is this statement true or false? Why?

Can an MNC reduce the impact of translation exposure by communicating? Explain.

How would you rank the relative importance of transaction exposure, economic exposure, and translation exposure? Explain...

How would you rank the relative importance of transaction exposure, economic exposure, and translation exposure? Explain your answer. If you are the decision maker, will you hedge translation exposure? There are two approaches of hedging: 1) hedge only when we expect an unfavorable movement in foreign exchange rate, and 2) hedge anyway regardless of our expectation of exchange rate movements. Which approach would you use and why?

Explain how multinationals can hedge transaction exposure using forwards and options and explain any differences in...

Explain how multinationals can hedge transaction exposure using forwards and options and explain any differences in using forwards and options to hedge currency exposure. Do companies need to always use derivatives such as forwards, futures and options to hedge transaction exposure? If not, explain why not?

Dow Chemical, a US-based firm, seeks to hedge most of the exposure of its European operations...

Dow Chemical, a US-based firm, seeks to hedge most of the exposure of its European operations by borrowing in Swiss francs (CHF). At the same time the French tire manufacturer Michelin is seeking US dollars to finance additional investment in its US manufacturing plants. Both firms want the equivalent of $150 million US dollars in fixed-rate financing for 10 years. Dow can issue dollar-denominated debt at an interest rate of 7.5 percent per year, or Swiss franc denominated debt at...

Should a firm always hedge the foreign exchange rate exposure?

MNCs can use several methods to hedge transaction exposure (futures hedge, forward hedge, Money market hedge...

MNCs can use several methods to hedge transaction exposure (futures hedge, forward hedge, Money market hedge and currency option hedge). Give an example of how a particular company hedges the translation exposure (mention which one(s) of these techniques

Know how a firm can hedge its interest rate risk on a short-term fixed or variable...

Know how a firm can hedge its interest rate risk on a short-term fixed or variable rate bank loan or on a fixed or variable rate short-term investment using the interest rate futures market. Be able to explain how there is a gain or loss if a firm with a variable rate bank loan expects interest rates to rise and attempts to hedge this expected interest rate risk in the interest rate futures market.

To hedge its exposure to the price of oil, an airline buys a call option on...

To hedge its exposure to the price of oil, an airline buys a call option on oil with the exercise price Kc and sells a put option with the exercise price Kp (Kp < Kc). Both contracts have the same size chosen such as to hedge the entire exposure, and their premiums are equal. On a diagram, show a) The unhedged exposure as a function of the future spot price of oil b) The gain from the call option as...

Question