93%(105)98 out of 105 people found this document helpful
This preview shows page 2 - 4 out of 4 pages.
What’s the best hedging strategy for Porsche? The design of an optimal hedging strategy is complicated by the fact that futuresales are uncertain. Hedging may be imperfect if the size of the hedge is not entirelyappropriate for the level of sales that the company actually achieves. What are the cash flow patterns produced by different hedging strategies? A forward hedge completely eliminates any dependence of net cash flows on theexchange rate if sales turn out to be equal to expected sales. However, if sales turn outto be lower (higher) than expected sales, then the forward hedge would leave Porscheoverhedged (underhedged) with the consequence that some foreign exchangeexposure remains. In the underhedged case, Porsche retains some of its unhedgedforeign exchange risk exposure (whereby a weak dollar reduces cash flow), while in theoverhedged case, Porsche’s foreign exchange exposure flips sign (whereby a strongdollar reduces cash flow).
The key difference of an options hedge is that options are not exercised if the dollaris strong. Therefore, cash flows are similar to cash flows without hedging (apart from thesmall cost paid to purchase the options). If the dollar is weak, the cash flows look likethose with the forward hedge (again apart from the small cost paid to purchase theoptions). Which strategy is better for Porsche? From the earlier discussion of motivations for hedging it is clear that alternativehedging strategies must be evaluated based on how well they eliminate downside risksthat could lead to financial distress and a need for costly external financing. The options hedge and the forward hedge expose Porsche to different downsiderisks when future sales are uncertain. The risks are similar when the dollar is weak: Inthis case, for both the options and the forward hedge, Porsche is underhedged if salesturn out to be higher than expected. However, when the dollar is stronger thanexpected, only the forward hedge carries substantial downside risks: If sales turn out tobe lower than expected then Porsche ends up overhedged. Thus, while both hedging strategies are similarly shareholder-value neutral in africtionless setting, the options hedge has the advantage of avoiding a potentially costlydownside scenario where sales are lower than expected and, at the same time, aforeign exchange hedge produces losses. For the purpose of avoiding states of distressand external financing needs, it seems preferable to avoid this kind of downsidescenario.