Managing Currency Risk with Financial and Operational Hedging Techniques Essay - 2165 Words
Introduction Overview of the hedging techniques
In the financial market, almost all of companies need to face the currency risk. In order to manage the currency risk, companies will use different hedging techniques, such as financial and operational hedging techniques. For example, money market, futures contracts, options and forwards contracts are commonly used by firms, as well as operational hedging techniques. All of 4 types of financial hedging techniques are short-term hedge. Money market is a part of financial markets for assets involved in short-term borrowing,lending, buying and selling. Its features are high liquidity, lower risk, such as treasury bills. Futures contracts are future transaction for buying or selling, and made by Futures exchange. The date and place of the transaction have been provided. There are some features of futures contracts. Quantity, commodity and quality have been limited, excepting the price. Also, it cannot be done over-the-counter. Options is a financial tool, which based on futures. If purchaser hold the options, he/she will has a right, not the obligation, to buy from or sell to the seller of the provided commodity in the future as the same price as the price agreed now. The last financial hedging technique, forwards contracts, is a non-standardization contact between two parties to sell or buy in the future. Curb-exchange and cash transaction are the feathers of forward contact.
This essay will focus on two operational hedging techniques, market selection strategy and plant location strategy. The first one suggests that firms should diversify products into many markets as possible. The second one suggests that firms need to find out which location will be
good for setting up production plant. Advantages and disadvantages of the hedging techniques Money market advantages 1. Fixed future rate 2. Flexible amount 3. To use it for currencies where forwards contacts cannot be used. Disadvantages 1. More complex 2. Fixed...
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Become a StudyMode Member你方六月十日的还盘内容以悉。很抱歉不能接受按你方还盘价格供货。我们认为产品的价格已经很合理，美元的不断贬值让我方在计算售价时必须考虑汇率风险。不要把我们的产品和一些非同一等级产品放在一起比较价格。 的翻译是：-Offer content to you on June 10. We regret being unable to accept your counter-offer price to supply. We regard product prices have very reasonable, dollars falling dollar makes us must consider when pricing currency risk. Do not combine our products and some non-compare prices in conjunction with
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你方六月十日的还盘内容以悉。很抱歉不能接受按你方还盘价格供货。我们认为产品的价格已经很合理，美元的不断贬值让我方在计算售价时必须考虑汇率风险。不要把我们的产品和一些非同一等级产品放在一起比较价格。
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-Offer content to you on June 10. We regret being unable to accept your counter-offer price to supply. We regard product prices have very reasonable, dollars falling dollar makes us must consider when pricing currency risk. Do not combine our products and some non-compare prices in conjunction with
-Offer content to you on June 10. We regret being unable to accept your counter-offer price to supply. We regard product prices have very reasonable, dollars falling dollar makes us must consider when pricing currency risk. Do not co
-Offer content to you on June 10. We regret being unable to accept your counter-offer price to supply. We regard product prices have very reasonable, dollars falling dollar makes us must consider when pricing currency risk. Do not combine our products and some non-compare prices in conjunction with
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You June 10 bargain the content by to learn.Was sorry very much cannot accept according to you bargains the price goods supply.We thought the product the price already very was reasonable, US dollar unceasing depreciation let us when the computation selling price had to consider the exchange rate ri
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& ahearing the news,she burst into crying and burst out the room. 听见新闻，她破裂了入哭泣并且破裂了屋子。 & a请输入您需要翻译的文本！the mean values for shrimp final weight the mean values for shrimp final weight & aall children have to face their own problems 所有孩子必须面对他们自己的问题 & acontent validity 内容的正确性 & aSO战略 SO strategy & atake or size the bull bey horns 采取或估量公牛土侯垫铁 & alooked at 看 & ait is of particular interest 它是特别的好处 & aFull IMEI Presentation - 充分的IMEI介绍- & a我认为吸烟有害健康 I think the smoking injurious to health & a你方六月十日的还盘内容以悉。很抱歉不能接受按你方还盘价格供货。我们认为产品的价格已经很合理，美元的不断贬值让我方在计算售价时必须考虑汇率风险。不要把我们的产品和一些非同一等级产品放在一起比较价格。 You June 10 bargain the content by to learn.Was sorry very much cannot accept according to you bargains the price goods supply.We thought the product the price already very was reasonable, US dollar unceasing depreciation let us when the computation selling price had to consider the exchange rate ri &2.1 Currency Risk Management_1 Currency Risk Exposures_2018年6月CFA三级系列课程：Risk Management
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付款完成后请根据您的情况点击下面按钮Currency risk arises from exchange rate moves between pairs of currencies.
If you have investments or assets in a foreign country with a different currency, you face currency risk, unless the foreign currency is pegged to your domestic currency or your exposure is hedged.
A simple example shows how currency risk affects your returns.
Suppose you’re an American investor and you put $10,000 into a European stock market . The fund is not hedged, and so you’re exposed to changes in the exchange rate between the dollar and the euro. That is, you’re exposed to currency risk.
Let’s say that over the next 12 months the European stock market and therefore your tracker goes up 20% in local euro terms:
If the dollar and the euro is at the same exchange rate after 12 months as when you first made your investment, your holding is now worth $12,000. (i.e. The $10,000 investment increased by 20%).
Say the dollar appreciated by 25% versus the euro over 12 months. Your holding would be worth $9,600 (12,000 / 1.25). i.e. Your euro position now buys fewer dollars.
What if the dollar depreciated by 25% versus the euro over 12 months? Your holding would now be worth $16,000 (12,000 / 0.75). i.e. Your euro position now buys more dollars.
As you can see, currency risk can dramatically affect your returns, from magnifying your gains to turning gains into losses in your own currency.
The basic rule is:
When the foreign currency strengthens versus your own currency, your overall return goes up.
When the foreign currency weakens versus your own currency, your overall return goes down.
Currency risk and businesses
Any business that operates across different territories that use different currencies will face currency risk. Businesses will be hurt and helped in different ways from exchange rate moves.
Some examples:
If you’re a
and your main market is Europe, you will benefit when the pound weakens. The euros you receive in return for your goods will be worth more pounds, so profits increase and/or your goods become more competitive due to their lower price in euro terms. The opposite happens when the pound strengthens.
What if instead you’re based in the UK, your main market is America – but you also use lots of raw materials priced in dollars? Here you will still benefit if your local currency depreciates versus the dollar, but some or all of the gains will be wiped out because of the extra cost of buying raw materials with more expensive dollars.
A multinational firm operating in lots of different countries may find these exchange rate moves broadly cancel each other out.
Companies sometimes hold debts in foreign currencies. An unhedged move in the exchange rate can greatly increase their debt burden if they service the debt via a different currency.
Companies often hedge exchange rate exposure to try to deal with currency risk. The theory is they should concentrate on their proper business, rather than have a side business in currency trading.
However hedging does cost money, and a poor call can make a big dent in profits.
Dealing with currency risk when investing
So much for business, what about the likes of us one-man investing bands?
Opinion is divided as to whether currency risk is a good thing for us. There is some academic evidence that exposure to currency
investors with higher returns. Others argue it increases diversification and , on top of the usual benefits of .
Hedging away the currency risk – which comes built into some funds and ETFs – has its own snags. It costs money, whether born separately by you as an investor, or in the shape of higher costs via a hedged fund. You also give up potential rewards, which is always the unarguable price of hedging but still annoying when it happens.
Some notable investors believe currency risks can be ignored if investing in overseas equities for long periods. , the grandfather of far-flung investing, believed currency movements were neutral over the long-term when investing in equities.
Overseas bond funds are usually best hedged though – the shorter life of bonds reduces the time for currency affects to even out.
Not all foreign investments expose you to currency risk, especially if you’re an American investor. Many emerging market countries have currencies pegged to the dollar. This means their currencies rise and fall with the dollar, so currency risk can be ignored by U.S. investors putting money there.
Hedging as a side product of an investment
Some investments are inherently hedged.
Suppose you’re a U.S. investor, and you buy shares in AstraZeneca, the UK-listed drugs giant.
The value of your investment is determined by:
a) the performance of the AstraZeneca share price, and
b) currency risk.
The currency danger for you as a U.S. investor is that the pound may fall versus the dollar after you’ve made your investment.
Let’s say you buy $1,000 worth of Astra shares at an exchange rate of $2 to ?1. You have ?500 in Astra shares.
Now suppose that after some years the pound falls to parity with the dollar, so ?1 is worth $1.
If the AstraZeneca share price stayed the same over the period, you’d have only $500 when you sold up and brought your pound sterling money back into dollars. You’d have lost $500 due to the change in the exchange rate.
However – the Astra share price would be very unlikely to stay the same if the exchange rate changed like this, because Astra does most of its business in dollars.
As the dollar strengthened towards parity with the pound, the dollars that Astra made overseas would be worth more pounds when repatriated back home to the UK.
Astra’s earnings and profits would thus rise in pound terms purely from this exchange rate change, and its share price would almost certainly rise too.
For US investors, such a rise in the share price could potentially cancel out for U.S. investors the loss from the exchange rate change!
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on money and investing. Please read my . You can . Stay updated via , , , or .Foreign Currency Risk: A Threat or Opportunity Toward Indonesia’s Economic Resilience?
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"Globalization turns the world to be more interconnected than before, which in turn shapes inter-dependency and relations among countries and increase the needs of foreign currency to perform international trade activities. As a part of the globalized world, Indonesia is also affected by the dynamics."
Currency is a generally accepted medium of exchange issued by government of a particular country and circulated within the economy. In other words, currency is any form of medium which is generally used for exchange or trade activities within a country. Most countries in the world have their own generally accepted currency. Since a country’s currency is usually only applicable for exchange within the country, we need to acquire other countries’ currency to be able to perform trade with other countries. That affects the demand and supply of the respective country’s currency based on the currency needs and determine its currency level against other countries’ currency. The fluctuations of a country’s currency level against the other give rise to uncertainty or risk to the country who needs other countries’ currency.
Globalization&turns the world to become more interconnected than before, which in turn shapes inter-dependency and relations among countries, and increase the needs of foreign currency to perform international trade activities. As a part of the globalized world, Indonesia is also affected by the dynamics. Indonesia is a developing country that needs to develop many aspects of its economy in order to produce & distribute social welfare to all of its citizens. In order to develop its economy, Indonesia is dependent on other countries’ assistance to fulfill and acquire its needs. Therefore, foreign currencies become necessary for Indonesia to perform its international trade and Indonesia becomes exposed to foreign currency fluctuation risk. In general, Indonesia needs foreign currency for financing activities (i.e. equity & debt) and operational activities/international trade (i.e. export & import).
Indonesia still relies heavily on foreign currency financing, both in public and private sector, to fuel its economic development. Based on Indonesia Central Bank’s data as of 31 May 2016, Indonesia foreign currency debt position was amounted to USD 314,3 billion, while its foreign currency reserve was only USD 103,6 billion. It means Indonesia’s total foreign currency debt is three times higher than its total foreign currency reserve (assets). This discrepancy could negatively impact Indonesia’s economic resilience as its total foreign currency reserve is not adequate to pay all of its total foreign currency debt assuming all debts are due at the same time.
Based on the Indonesia Central Bank’s data as of 31 May % of the total foreign currency debt belongs to the private sector, while the rest 47.9% belongs to the public sector. Unlike the public sector, the private sector’s debt is difficult to supervise and regulate since private sector is broad and there is no centered or coordinated measure for foreign currency fluctuation risk management within the private sector. This makes private sector’s foreign currency debt exposed to higher foreign currency risk. For instance, PT Kawasan Industri Jababeka Tbk, an industrial estate and property company, has net foreign currency debt amounted to USD 242.5 million. From its total foreign currency debt, the company has a senior guaranteed debt amounted to USD 70 million with interest rate of 7.5% p.a. and due in 2019. It makes the company more sensitive to foreign currency fluctuation and the company might not be able to repay its principal and interest of its debt if USD currency level is appreciated to some extent. If the company cannot repay its debt, it has to sell some of its assets or even liquidate the company to repay the debt. This will lead to rise of unemployment rate and hindrance to national economic development since the company cannot run its business anymore.
In international trade, Indonesia still relies heavily on import to fulfill the country’s needs. Moreover, there are many industries and business sector in Indonesia which expenses are mostly in foreign currency while the revenues attained are in rupiah denomination, such as airplane transportation sector. This will make Indonesia more prone to foreign currency appreciation against rupiah since the industry cannot hedge its foreign currency denominated operational expenses with its revenue. For instance, 90% of PT Garuda Indonesia Tbk’s operational expenses are in US Dollar denomination, while 100% of its revenue is in rupiah denomination. This led to loss on foreign exchange amounted IDR 242 billion that PT Garuda Indonesia Tbk suffered during 2015 due to its inability to naturally hedge its foreign currency’s expenses fluctuation with its revenues.
Even though foreign currency fluctuation gives rise&to several&potential threats toward Indonesia's economic resilience, it also offers opportunity to strengthen national economic resilience through several strategies. For instance, China implemented ‘crawling-like peg’ monetary policy, which allows its currency rate to be&several percentage lower than US Dollar. Since China had previously built its manufacturing capability and competitiveness, the low currency rate helps China to export its manufactured products at low prices, thus adding China’s product price competitiveness compared to other country’s similar products. By doing so, China is able to sustain high economy growth rate through increasing its export along with its domestic consumption.
The government of Indonesia has taken several measures to stabilize foreign currency fluctuations against Rupiah. Indonesia Central Bank has issued SE BI No. 17/11/DKSP dated 1 June 2015 regarding obligation of IDR currency usage for transactions in Indonesia to increase the demand of Rupiah and decrease the needs of foreign currency, so Rupiah’s level could appreciate against major foreign currencies such as US Dollar. Besides that, Indonesia Central Bank also issued Central Bank Regulation No. 16/21/PBI/2014 regarding prudential principle for non-bank private sector foreign debt to push the private sector to be more prudent in their foreign currency risk management and prevent national industry from collapsing due to depreciation of Rupiah’s level against major foreign currency. Since the regulation&was implemented, the total amount of non-bank private sector foreign currency hedging has increased from USD 548 million in 2014 to USD 1.84 billion in %), which indicated that private sector has implemented more prudential measures in their foreign currency risk management.&Furthermore, the government of Indonesia has also released the 1st economic policy package concerning macroeconomic stabilization through fiscal & monetary policy, including control of inflation. These policies could catalyst the government’s effort of Rupiah’s rate stabilization.
To manage Indonesia's&foreign currency fluctuation risk well and gain advantage from it, there are several strategies that could be implemented as followed.
Implementing Good Corporate Governance (GCG) & prudential principle in foreign currency risk management, such as frequent control of company’s foreign currency debt position and sensitivity toward foreign currency fluctuation or setting a particular threshold&for foreign currency financing, so private sector could manage its foreign currency risk well.
Enhancing coordination&between government institutions, State-Owned Enterprises, private sector, and other stakeholders for exchange of information, coordinated strategy, and coordinated supervision to mitigate foreign currency risk.
Increasing the usage of domestic resources for industry operational activities to minimize foreign currency risk exposure for private sector which revenue is in rupiah.
Establishing a good international trade strategy & policy to increase&Indonesia's foreign currency reserve and gain benefits from foreign exchange rate fluctuations (e.g. building value-added manufacturing capability to increase export & increase our national foreign currency reserve).
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