Question

How does hedging increase firm value? From the dicounted casf flow (DCF) method perspective, can you explain how hedging usind derivative contracts can increase the value of a firm?

Answer 1

Hedging will increase the firm value as hedging will be resulting into mitigation of the risk and the losses which are associated with the exposure of the company and which can reduce the profit of the company to a large extent so hedging will be taking all such position that will eliminate the loss to a large extent and it will maintain the profit for the company and it will mean that the company will be having lower cost associated with hedging also in order to reduce the losses to a large extent.

YES, when we are adopting discounting cash flow method then hedging can be leading to increase the value of cash flows because when we have taken the position using the derivative contracts, we will not be adjusting the cash flows for the exchange rate fluctuation or other risk adjustment because we have already mitigated these risk using the derivative contract, so we can use the cash flows to their exact amount and we can discount cash flow at the present because we have already eliminated the risk associated with the fluctuation in the cash flows by taking a derivative contract through hedging and it will mean that derivative contract will be protecting the fluctuation in the cash flows and it will be leading to stability in the cash flows for the longer period of time and it will also mean that when the cash flows are recorded at their true and fair value then we are having a higher value of the discounted cash flows because we have not adjusted discounted cash flow, as we have already taken derivative contract which will hedge our position.