Question

As a company, what is the single most important reason for hedging its foreign currency risk? Please elaborate.

Answer 1

For a company , specifically an MNC or Multinational company , it c crucial for them to manage the foreign currency risk in order to hedge from the Translation Risk in the financial reporting.

· A company having operating subsidiaries in multiple location or in case of MNC having operations in multiple geographies, the cash flows are denominated in different home currency of the operations.

· While the performance of a particular subsidiary or unit is profitable for the company , it is due to the translation risk in the changes and the fluctuations of the currency exchange rates that these untranslated profits are depleted in the consolidated reporting’s

· Hence at the time of audit , When these earnings are consolidate d in the gross Balance sheet of the company, any adverse fluctuations I n the rates can cause increase in the exposure for the company.

o Overexposure in the Debt profile s of the company

o Exposure to the cash flows of the company

o Adverse changes in the Operating profits of the company

Hence every company uses proper financial derivatives to hedge the foreign currency risks with

· Futures contract

· Currency derivatives

· Swap Contracts ,

· Interest rate derivative in order to hedge against these translation risks