Whats the best hedging strategy for porsche the

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What’s the best hedging strategy for Porsche? The design of an optimal hedging strategy is complicated by the fact that future sales are uncertain. Hedging may be imperfect if the size of the hedge is not entirely appropriate 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 the exchange rate if sales turn out to be equal to expected sales. However, if sales turn out to be lower (higher) than expected sales, then the forward hedge would leave Porsche overhedged (underhedged) with the consequence that some foreign exchange exposure remains. In the underhedged case, Porsche retains some of its unhedged foreign exchange risk exposure (whereby a weak dollar reduces cash flow), while in the overhedged case, Porsche’s foreign exchange exposure flips sign (whereby a strong dollar reduces cash flow).
The key difference of an options hedge is that options are not exercised if the dollar is strong. Therefore, cash flows are similar to cash flows without hedging (apart from the small cost paid to purchase the options). If the dollar is weak, the cash flows look like those with the forward hedge (again apart from the small cost paid to purchase the options). Which strategy is better for Porsche? From the earlier discussion of motivations for hedging it is clear that alternative hedging strategies must be evaluated based on how well they eliminate downside risks that could lead to financial distress and a need for costly external financing. The options hedge and the forward hedge expose Porsche to different downside risks when future sales are uncertain. The risks are similar when the dollar is weak: In this case, for both the options and the forward hedge, Porsche is underhedged if sales turn out to be higher than expected. However, when the dollar is stronger than expected, only the forward hedge carries substantial downside risks: If sales turn out to be lower than expected then Porsche ends up overhedged. Thus, while both hedging strategies are similarly shareholder-value neutral in a frictionless setting, the options hedge has the advantage of avoiding a potentially costly downside scenario where sales are lower than expected and, at the same time, a foreign exchange hedge produces losses. For the purpose of avoiding states of distress and external financing needs, it seems preferable to avoid this kind of downside scenario.

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