Question

Assume that you have decided to hedge future payables that are coming from your Myanmar to a US MNC. How would the US MNC hedge these payables? Please go through the specific steps required to hedge for 1 million dollars of payables. Please use numbers. There is more than one way to hedge. You only need to choose one to go through, however, I would like you to describe the other methods.

Answer 1

What is hedging?

Sol:- Hedging in very simple word is mitigating the risk involved in any financial transaction.

U.S company is lets suppose making a purchase of an item (let it be cloths) from myanmar worth 1 million dollar. It must take a long position in the future contract to hedge this deal.

Long Position :- Long position is nothing but just buying financial instrument such as commodities, stocks, currencies etc..

Future Contracts:- Future Contracts is one of the very interesting financial tool to mitigate the risk by getting into legal agreement to buy or sell a particular asset at predetermined price at a specific time in the future. Nobody knows about the future but in finance we know about it and trade into futures (isn't it funny, but this is also the beauty of this subject).

So, we do not know about the situation of mynamar in future, may it can collapse or some military uprising may take place. Which can lead the price to rise or whatever, the price can destabilise. Business hate destabilization, so to counter or arrest the effect they get long into the future contracts.

Lets understand it by an example:-

U.S bought 100000 units of cloths worth $1000000 from myanmar, means 1 unit of cloth worth $10.

Lets assume this deal will be fulfilled in 6 moths time.

By looking at present condition of mynamar, U.S MNC goes long on future contract with Mynamar MNC. The terms they were agreed upon that whatever the situation be they are going to honor the deal in $10 per unit.

Now understand the hedging part of it, Lets suppose the country gets destabilised by the rohingys muslims and the price gets shot up by $12 per unit cloth. In this situation, Mynamar's MNC is bound to supply the cloths on the prespecified price of $10 per unit cloth. Hence U.S MNC saved $2 Per unit cloth and $200000 in entire deal. This is the beauty of hedging...