Managing Transaction Exposure C H A P T E R 11 Managing Transaction Exposure

Chapter Overview A. Transaction Exposure B. Hedging Exposure to Payables C. Hedging Exposure to Receivables D. Limitations of Hedging E. Hedging Long-Term Transaction Exposure F. Alternative Hedging Techniques

Chapter 11 Objectives This chapter will: A. Compare the commonly used techniques to hedge payables B. Compare the commonly used techniques to hedge receivables C. Explain how to hedge long-term transaction exposure D. Suggest other methods of reducing exchange rate risk when hedging techniques are not available

A. Transaction Exposure 1. Identifying Net Transaction Exposure 2. Adjusting the Invoice Policy to Manage a. Aligning Manager Compensation with Hedging Goals

B. Hedging Exposure to Payables 1. Hedging Techniques for Payables a. Futures b. Forward c. Money Market d. Currency option

B. Hedging Exposure to Payables 2. Forward or Futures Hedge contract specifies a. Fixed amount of currency b. Fixed exchange rate c. Fixed delivery date 3. Money Market Hedge involves taking a money market position to cover a future payables or receivables position. a. Hedging with a Money Market Hedge versus a Forward Hedge

B. Hedging Exposure to Payables 4. Currency Option Hedge a. Using Calls b. Cost of Using Calls to Hedge c. Cost of Hedging with Calls Based on Currency Forecasts d. Consideration of Alternative Call Options

Contingency Graph for Hedging Payables With Call Options 11.1

B. Hedging Exposure to Payables e. Selecting the Optimal Technique for Hedging Payables: Steps to take a. since the futures and forward hedge are very similar, the MNC only needs to consider whichever one of these techniques it prefers. b. when comparing the forward (or futures) hedge to the money market hedge, the MNC can easily determine which hedge is more desirable

Graphic Comparison of Techniques to Hedge Payables 11.4

B. Hedging Exposure to Payables 5. Optimal Hedge vs. No Hedge 6. Evaluating the Hedge Decision

C. Hedging Exposure to Receivables 1. Forward or Futures Hedge 2. Money Market Hedge 3. Put Option Hedge a. Cost of Hedging with Put Options b. Cost of Hedging with Puts Based on Currency Forecasts c. Consideration of Alternative Put Options

Contingency Graph for Hedging Receivable with Put Options 11.5

C. Hedging Exposure to Receivables 4. Selecting the Optimal Technique for Hedging Receivables 5. Optimal Hedge vs. No Hedge 6. Evaluating the Hedge Decision 7. Comparison of Hedging Techniques 8. Hedging Policies of MNCs a. Hedging Most of the Exposure b. Hedging None of the Exposure c. Selective Hedging

D. Limitations of Hedging 1. Limitations of Hedging an Uncertain Amount 2. Limitation of Repeated Short-Term Hedging

11.10 11.11 Illustration of Repeated Hedging of Foreign Payables When the Foreign Currency is Appreciating 11.10 11.11 Long Term Hedging of Payables When the Foreign Currency is Appreciating

E. Hedging Long-Term Transaction Exposure 1. Two Techniques: a. Long-term Forward Contract b. Parallel Loan

F. Alternative Hedging Techniques 1. Three Alternatives: a. Leading and Lagging b. Cross-Hedging c. Currency Diversification