Question

Discuss methods the company used to hedge foreign exchange exposure such as the use of forward, futures, options, money market, or swap agreements and support with financial information from the past year

Answer 1

Methods used by the company to hedge foreign exchange exposure

Foreign exchange exposure is the risk arising out of foreign exchange transactions of a company. The companies use the following techniques to hedge against this risk;

1. Forward : These contracts are agreement between two parties to buy or sell a specified quantity of asset at a fixed price on a specific date in future. The price at which the asset is to be sold is fixed in advance. This will reduce the risk of variability in the cash flows.
2. Futures : These contracts are similar to forward contract, but are standardised in nature. It involves an agreement between two parties to buy or sell the asset for a fixed price on a fixed date in future.
3. Options : These are contracts which gives the holder the right to buy or sell an underlying asset at a fixed price over a specified period of time. Options gives the right to buy but not the obligation. Options can be used to hedge risk.
4. Money market : Money market is a financial market where short term securities are bought and sold. Money market instruments like treasury bills, commercial papers etc can be used to hedge foreign exchange exposure.
5. Swap agreements : These are agreements between two parties to exchange the series of cash flow in one currency for a series of cash flow in another currency over a given period. The liability is exchanged here.