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The paper is concentrated around the discussion of hedging as one of the options for insuring the firm from financial risks, and thus losses. Hedging is the integral part of any business risk management and at present time is the best choice for those, who want to be sure in future profitability of the enterprise. However, hedging poses some questions and challenges and very often becomes a cornerstone in the business activity. Thus, the work will describe and argument the necessity of hedging in the modern business world. To Hedge or not to Hedge The purpose of the paper is to provide the brief summary of all arguments and contra-arguments of hedging as the main present-day option for insuring financial risks.
However, it would probably be more correct to note, that the purpose of the work is to prove the necessity of hedging in the present-day business, despite the fact that many enterprises still refuse from it, making stress on its high costs. The main conclusion of the work is that hedging is definitely necessary for multinational corporations to insure the risks of rate fluctuations and ensure the profitability of the whole business operation. The multinational firm operations are extremely dependent on the exchange rates, the changes of which may even bring the break of the firm. The main impact of the exchange rates on the firm lies in the uncertainty, at what exchange rates will be sold the money which will be delivered to the corporation from abroad after the conditions of the contract is fulfilled. The exchange rate is never stable, and it is definite, that this uncertainty often brings the desirable fast profits for those, who operate on the financial market, but it is even more often that for multinational corporations such fluctuations may cause substantial financial losses, which should be insured, and hedging is the best choice for the stability of the corporation. It is usually, that managers, having known about the opportunity of hedging, rub their hands and are ready to protect their assets from the unfavorable changes of exchange rates immediately, however, understanding that this process demands considerable finances and is connected with significant costs, they at once find a huge number of reasons, which would tell that hedging is too much for the company.
It is paradoxical, but is a fact that often managers prefer losing money in their main business activity to carrying certain expenses to protect their assets. There exist three kinds of risks, which arise as a result of exchange rates fluctuations' impact: transactional risks, which are connected with the influence of exchange rates on the flow of finances which come from sales or purchases; translational risks, connected with the change of assets value abroad, as a result of changes in the prices of foreign currency; economic risks, which influence the core business of the corporation. (web) Looking closer at hedging as one of the options in risk management, it should be admitted, that it still has more advantages than costs. There is no argument about the fact, that costs of hedging are too high at times, but they become the main instrument of saving the corporation from much bigger financial losses. 'Hedging objectives vary widely from firm to firm, even though it appears to be a fairly standard problem, on the face of it; and the spectrum of hedging instruments available to the corporate Treasurer is becoming more complex every day. ' (Fargnoli, 2005) The first advantage of hedging is that it allows to secure the changes of the exchange rates on the financial markets and thus prevent their negative influence on the multinational corporation' operation, the same as companies insure themselves from the risks of theft or fire. The main aim of hedging is in 'the elimination of the uncertainty in relation to the future financial flows, which allows having firm knowledge of the future incomes amount as a result of business activity. Hedging in modern economy carries broader meaning, being applied to all risks which have their origin in external factors. ' (Ross, 2003) 'Another reason for hedging the exposure of the firm to its financial price risk is to improve or maintain the competitiveness of the firm. Companies do not exist in isolation.
They compete with other domestic companies in their sector and with companies located in other countries that produce similar goods for sale in the global marketplace. ' (Giorgio, 1996) In connection with multinational corporations, hedging ultimately leads to the decrease of prices for the products, which the corporation manufactures. This decrease owes to the fact that the risks are insured and thus possible losses do not need to be included into the price. The price, lower in comparison with that of other similar producers adds to the level of competitiveness of the corporation on the global market. On the other hand, if three similar corporations in one sector of global economy work with the same products, and two of them use hedging as an instrument of insuring the possible financial risks, it is obvious that the third one will considerably lose in its competitiveness. Corporations which use effective risk management programs reduce the need of funding the losses and work for the long-term benefit on the market.
Simultaneously, hedging poses some problems and has several serious disadvantages, which should be considered at the time the risk management strategy of the corporation is developed. First of all, multinational corporation managers are often doubtful getting to know how much hedging would cost to their company. On the other hand, they rarely take into account the possible losses which the absence of hedging might bring to them. (Bernstein, 1999) Thus, the main objective here is to weight the uncertainties and the opportunity loss. If hedging costs 5 - 6 million dollars which should be distracted form the main financial flow, but the possible risks equal to 200 - 300 million, there can be no doubts that hedging is 100 % necessary in this situation. How can one speak about distracting finances if these actions provide 10 - 12 % of income flow increase?
The problem of decreasing the costs of hedging is easily solved through the use of various financial instruments and technologies. Another problem of hedging is that ' hedging is contingent on the preferences of the firm's shareholders. There are companies whose shareholders refuse to take anything that appears to be financial price risk while there are other companies whose shareholders have a more knowing view of such things. It is easy to imagine two companies operating in the same sector with the same exposure to fluctuations in financial prices that conduct completely different policy, purely by virtue of the differences in their shareholders' attitude towards risk. ' (web) Thus, it is very important to make shareholders sure in the necessity of spending a portion of profits for the process of hedging.
There exist some other instruments of financial risk management, one of the most important among them are the derivatives. These instruments, in fact, are closely connected with the notion of hedging, but are somewhat different. It should be pointed out, that the derivative market is rapidly growing, and there are about 2. 5 million of financial instruments on the market at present, compared to only 200 thousand several years ago. (Fargnoli, 2005) However, the market of derivatives has been created only with one aim to cover financial risks which corporations might encounter. The choice of derivatives to cover the risks is the absolute choice of the Treasurer and depends on his qualification and skills. Hedging is definitely necessary for multinational corporations to ensure their business activity from the risks of exchange rates fluctuations. Despite the fact that hedging is often a very expensive option, but considering all factors, uncertainties and opportunities, it is mostly the best choice for multinational and other companies. 'The single most important point to take away from this material is that financial risk management is critical to the survival of any non-financial corporation.
Investors who have real money at risk must understand the exposures facing the firms in which they invest, they must know the extent of risk management at these companies and they must be able to distinguish between good risk management programs and bad ones. Without this information, they may be in for some ugly surprises. ' (web) It should be remembered, that all costs of hedging are compensated and all problems which arise in the process, can be easily solved, while compensating the losses which the absence of hedging may bring will be much more troublesome and at times even impossible. International companies annually lose billions of dollars for the lack of knowledge in the sphere of risk management. These losses will never equal to the necessary expenditures for carrying out hedging. As any phenomenon has its drawbacks and positive sides, hedging puts some challenges to the modern business society, though should be viewed as one of the best ways out in the attempt to insure financial risks and the impact which exchange rate fluctuations make on the work of multinational companies. References (1) Bernstein, William. (1999).
To hedge or not to hedge. Get over it. Available at web (2) Bill, Udo. (1996) Imperfect hedging and export production. Southern Economic Journal 62 - 3, 667 - 689 (3) Fargnoli, Devin. (2005, January, 18) To hedge or not to hedge? Available at web (4) Giorgio, Emmanuelle Moors. (1996). The secret of successful hedging.
African Business 212, 46 - 49 (5) Ross, Derek. (2002) Corporate money to hedge or not to hedge. Accountancy 130 - 1311, 1 (6) Ross, Derek. (2003) Corporate money is hedging worth it? Accountancy 141, 1 (7) What is hedging? Why do companies hedge? Available at: web
Free research essays on topics related to: risk management, financial instruments, exchange rates, multinational corporations, financial losses
Research essay sample on Multinational Corporations Exchange Rates
