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Cross-Hedging Minor Currency Exposure
Cross-Hedging involves hedging a position in one asset by taking a position in another asset.The effectiveness of cross-hedging depends upon how well the assets are correlated.◦An example would be a U.S. importer with liabilities in Swedish krona hedging with long or short forward contracts on the euro. If the krona is expensive when the euro is expensive, or even if the krona is cheap when the euro is expensive it can be a good hedge. But they need to co-vary in a predictable way.Cross-Hedging Minor Currency Exposure
If only certain contingencies give rise to exposure, then options can be effective insurance.For example, if your firm is bidding on a hydroelectric dam project in Canada, you will need to hedge the Canadian-U.S. dollar exchange rate only if your bid wins the contract. Your firm can hedge this contingent risk with options.Hedging Contingent Exposure
Recall that swap contracts can be viewed as a portfolio of forward contracts.Firms that have recurrent exposure can very likely hedge their exchange risk at a lower cost with swaps than with a program of hedging each exposure as it comes along.It is also the case that swaps are available in longer-terms than futures and forwards.Hedging Recurrent Exposure with Swaps
The firm can shift, share, ordiversify:◦shift exchange rate risk by invoicing foreign sales in home currency◦share exchange rate riskby pro-rating the currency of the invoice between foreign and home currencies◦diversify exchange rate riskby using a market basket indexHedging through Invoice Currency
If a currency is appreciating, pay those bills denominated in that currency early; let customers in that country pay late as long as they are paying in that currency.If a currency is depreciating, give incentives to customers who owe you in that currency to pay early; pay your obligations denominated in that currency as late as your contracts will allow.Hedging via Lead and Lag
A multinational firm should not consider deals in isolation, but should focus on hedging the firm as a portfolio of currency positions.◦As an example, consider a U.S.-based multinational with Korean won receivables and Japanese yen payables. Since the won and the yen tend to move in similar directions against the U.S. dollar, the firm can just wait until these accounts come due and just buy yen with won.◦Even if it’s not a perfect hedge, it may be too expensive or impractical to hedge each currency separately.Exposure Netting
Many multinational firms use a reinvoice center. Which is a financial subsidiary that nets out the intrafirm transactions.Once the residual exposure is determined, then the firm implements hedging.