Managing Exchange Rate Risk Through Hedging - Paper on Finance and Investments

Date:  2021-03-26 23:11:49
3 pages  (599 words)
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This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.
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This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

It is worth pointing out that multinational corporations constitute a tremendous concentration of power given the fact that they operate globally. They have a diverse market, and therefore they deal with a variety of currencies from different countries. Currency volatility and changes in currency exchange rates can have a tremendous impact on the cost of operations and the profitability of a company. This paper, therefore, intends to explain the type of currency risks that Ford Motor Company Is vulnerable to and the techniques that can help to manage that risk.

Most of the exchange rate risk at Ford Motor Company derives from a mismatch between the currency of its receivables and the currency of the debt that funds those receivables. This type of risk also known as the transaction risk whereby an exchange rate is likely to trigger a direct transaction exchange rate risk to the company.One of the best techniques used to reduce the volatility that is induced by exchange rate changes is the use of long-term hedging. Long term hedging involves swiping across two currencies i.e. undertaking a currency swipe at the beginning of a loan contract and the other one at a later date. Through long-term hedging, the company can fund its receivables with debt that is in the same currency and this process gives the company the advantage of reducing the movement of money from place to place. However, when the funding is in a different currency from the receivables, the company should apply techniques that ensure that the funding is similar to the currency of the receivables (Teece, Peteraf, & Leih, 2016).

One of the advantages of a long-term hedge is that it reduces the risk of over hedging in comparison to the short-term hedging. It is, therefore, important for the CFO to understand the enterprise risk management to avoid over-hedging.

A key point to note is that the company should only hedge the minimum payment that can be ascertained to prevent the possibility of over-hedging. The company, therefore, is able to reduce it cash flow movements significantly and this reduces the variance between the hedge and the actual risk. Hedging the minimum payments helps the company to avoid the costs that are involved in maintaining a long-term hedge.

One of the advantages of hedging is that it enables a company to protect its profit margins by providing immunity against currency fluctuations to the business. Currency rate fluctuations have the ability to affect the profits of a company and reduce the value of its assets. Moreover, hedging helps the company to contain its operation costs without passing these costs to the consumers and thus the company can retain them. It is worth pointing out that transmitting exchange rate costs to consumers, has the implication of giving away customers to competitors who have better techniques for managing the exchange rate risk (Markham, 2015).

The hedging strategy of an organization should involve four steps that entail first identifying the exchange rate risk and secondly evaluating the financial impact of the risk. Thirdly, the company should establish strategies that help to movement of its currencies to know the amount of money to hedge. Finally, a company should have an oversight committee that helps it to help it evaluate the suitability of hedging instruments and to manage the overall strategy.

References

Markham, J. W. (2015). A financial history of modern US Corporate Scandals: From Enron to Reform. Routledge.Teece, D., Peteraf, M. A., & Leih, S. (2016). Dynamic Capabilities and Organizational Agility: Risk, Uncertainty and Entrepreneurial Management in the Innovation Economy. Uncertainty and Entrepreneurial Management in the Innovation Economy (April 7, 2016).

 

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