Question

Volkswagen saw a 95% drop in its fourth quarter profits in 2004 after an unexpected surge in the value of the Euro left the company with losses of $1.5 billion.

1. What is hedging? Explain how Volkswagen's failure to fully protect itself against foreign exchange fluctuations had a negative effect on the company? What can Volkswagen and other companies learn from this experience?

2. Why was Volkswagen so vulnerable to the change in the value of the Euro against the US Dollar relative to the US Dollar?

3. In 2015 and 2016 strong dollar affected several US companies. Please see the one of the examples in the following links (2015 and 2016) where the strong dollar hurt the company. What can this company do to protect itself from exchange rate fluctuations? Since the beginning of 2017, the dollar has been weakening. What does that mean for US companies? How will the weaker dollar affect US businesses?  

only need to anwser to question 3

Answer 1

HEDGING

A HEDGE IS AN INVESTMENT TO REDUCE THE RISK IN AN ASSET DUE TO ADVERSE RISK OF PRICE MOVEMENTS. IT COULD BE A PART OF A FUTURE CONTRACT TAKEN IN AN OFFSETTING POSITION FOR SECURITY

IT IS AN ADVANCED INVESTMENT STRATEGY CAN ALSO BE TERMED AS AN INVESTMENT POSITION INTENDED TO OFFSET POTENTIAL LOSSES THAT MAY BE INCURRED BY AN INVESTMENT. IT IS MORE LIKE TRANSFERING OF RISK WITHOUT BUYING OF INSURANCE POLICIES

HEDGE IS AN INVESTMENT MADE INORDER TO SECURE AND PROTECT FINANCES FROM RISK AND RISKY SITUATIONS AND HEDGING IS DONE TO MINIMISE THE CHANCE OR TO OFFSET THE CHANCE THAT THE ASSTES WOULD LOSE VALUE IN THE FUTURE. IT ALSO LIMITS YOUR LOSS TO A KNOWN AMOUNT IF THE ASSEST DOES LOSE THE VALUE

AN EXAMPLE OF HEDGE IS AN INVESTMENT IN GOLD TO PROTECT ONESELF FORM EFFECTS OF INFLATION. GOLD IS A HEDGE AGAINST THE DOLLAR COLLAPSE. DOLLAR BEING THE WORLDS GLOBAL CURRNECY AND IF IT COLLAPSES THEN THE GOLD COULD BE REPLACED AS A MONEY UNIT. THE VALUE OF GOLD REAMINS THE SAME WHEN THE DOLLAR FLUCTUATES

VOLKSWAGON WAS KNOWN AS THE LARGEST CARMAKER IN EUROPE UNTIL RECENTLY AND A 95 DROP WAS REPORTED IN2003 AND IN THE FOURTH QUATER PROFITS DRASTICALLY SLUMMED FORM 1.05BILLION EUROS TO 50MILLION EUROS. THE PROFITS FELL ALMOST 50% WHICH WAS CAUSED BY VARIOUS FACTORS BUT THE CORE REASOND TO THE SLUM OF THE PROFITS WAS DUE TO THE UNPRECEDENTED RISE IN VALUE OF EUROS AGAINST DOLLARS. WHILE VOLKSWAGON HEDGED ONLY 30% OF ITZ FOREIGH CURRENCY EXPOSURE AS OPPOSED TO THE 70% IT HAD HEDGED TRADITIONALLY.

THE RISE IN THE VALUE OF EURO AND THE CURRENCY UNIT FOR 12 MEMBER EUROPEAN UNIONS TOOK MANY COMPANUES BY SUPRISE.IT WAS A VOLATILE TARDING HISTORY AGAINST THE US DOLLARS.

A STRONG DOLLAR CAN AFFECT AND HURT THE EMERGING MARKETS BECUASE ALONG WITH THE EMERGING MARKETS, THE GOVERNMENT, CORPORATIONS AND BANKS HAVE TAKEN ADVANTAGE OF LOW COST DOLLAR FINANACE TO RAISE THEIR FINANCES. THE BORROWINGS OF THESE HAD ALMOST DOUBLED IN THE PAST YEARS. THE CURRENCY DEVALUATION CAUSED BY THE REVERSAL OF CAPITAL FLOWS WOULD DEEPEN THE DOLLAR DEBT AND MAKE SREVICING MORE DIFFICULT. THE US FEDERAL RESERVE BANK INCREASED THE INTEREST RATES,THE HIGHER INTEREST RATES WOULD MAKE IT MORE EXPENSIVE FOR THE OVERSEAS BORROWERS TO SERVICE THEIR DEBT COMMITMENTS. WHILE HIGHER INTEREST RATES MAKE IT DIFFICULT FOR THE EMERGING MARKETS BY A REVERSAL FLOW OF CAPITAL BECUASE THEY ARE HIGHLY DEPENDANT UPON FOREIGN INFLOWS TO FUND FISCAL AND CURRENT ACCOUNT DEFICIT. DURING THAT PERIOS THE EMERGING MARKEYS RECEIVED 4.5 TRILLION DOLLAR OF GROSS CAPITAL FLOW, DUE TO HIGH INVESTMENT RETURNS,INTERNATIONAL CAPITAL FLOWS AWAY FROM THEM MAKING FUNDING A TWIN DEFICIT AND DIFFICULT TO ACHIEVE.