IFM_IM_ch11 - Chapter 11 Managing Transaction Exposure...

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Chapter 11 Managing Transaction Exposure Lecture Outline Transaction Exposure Identifying Net Transaction Exposure Adjusting the Invoice Policy to Manage Exposure Hedging Exposure to Payables Forward or Futures Hedge on Payables Money Market Hedge on Payables Call Option Hedge Summary of Techniques Used to Hedge Payables Selecting the Optimal Technique for Hedging Payables Optimal Hedge versus No Hedge Evaluating the Hedge Decision Hedging Exposure to Receivables Forward or Futures Hedge on Receivables Money Market Hedge on Receivables Put Option Hedge Selecting the Optimal Technique for Hedging Receivables Optimal Hedge versus No Hedge Evaluating the Hedge Decision Comparison of Hedging Techniques Hedging Policies of MNCs Limitations of Hedging Limitation of Hedging an Uncertain Amount Limitation of Repeated Short-Term Hedging Hedging Long-Term Transaction Exposure Long-Term Forward Contract Parallel Loan Alternative Hedging Techniques Leading and Lagging Cross-Hedging Currency Diversification 169
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170 International Financial Management Chapter Theme A primary objective of the chapter is to provide an overview of hedging techniques. Yet, transaction exposure cannot always be hedged in all cases. Even when it can be hedged, the firm must decide whether a hedge is feasible. While a firm will only know for sure whether hedging is worthwhile after the period of concern, it can incorporate its expectations about future exchange rates, future inflows and outflows, as well as its degree of risk aversion to make hedging decisions. Topics to Stimulate Class Discussion 1. Is transaction exposure relevant? 2. Why should a firm bother identifying net transaction exposure? 3. Should management of transaction exposure be conducted at the subsidiary level or at the centralized level? Why? 4. Assume that you decided to hedge future payables of 1 million Swiss francs using the forward hedge. Go through the specific steps required for you to use the forward hedge of 1 million francs. 5. Assume that you decided to hedge future receivables of 1 million Canadian dollars using currency options. Go through the specific steps required for you to use currency options to hedge this position. POINT/COUNTER-POINT: Should an MNC Risk Overhedging? POINT: Yes. MNCs have some “unanticipated” transactions that occur without any advance notice. They should attempt to forecast the net cash flows in each currency due to unanticipated transactions based on the previous net cash flows for that currency in a previous period. Even though it would be impossible to forecast the volume of these unanticipated transactions per day, it may be possible to forecast the volume on a monthly basis. For example, if an MNC has net cash flows between 3,000,000 and 4,000,000 Philippine pesos every month, it may presume that it will receive at least 3,000,000 pesos in each of the next few months unless conditions change. Thus, it can hedge a position of 3,000,0000 in pesos by selling that amount of pesos forward or buying put options on that
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IFM_IM_ch11 - Chapter 11 Managing Transaction Exposure...

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