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C11-,*,Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,Managing Transaction Exposure,11,Chapter,South-Western/Thomson Learning 2003,See,c11.xls,for spreadsheets to accompany this chapter.,Chapter Objectives,To identify the commonly used techniques for hedging transaction exposure;,To explain how each technique can be used to hedge future payables and receivables;,To compare the advantages and disadvantages of the identified hedging techniques;and,Chapter Objectives,To suggest other methods of reducing exchange rate risk when hedging techniques are not available.,Transaction exposure,exists when the future cash transactions of a firm are affected by exchange rate fluctuations.,When transaction exposure exists,the firm faces three major tasks:,Identify its degree of transaction exposure,Decide whether to hedge its exposure,and,Choose among the available hedging techniques if it decides on hedging.,Transaction Exposure,Identifying Net Transaction Exposure,Centralized Approach,-A centralized group consolidates subsidiary reports to identify,for the MNC as a whole,the expected net positions in each foreign currency for the upcoming period(s).,Note that sometimes,a firm may be able to reduce its transaction exposure by pricing some of its exports in the same currency as that needed to pay for its imports.,Techniques to Eliminate Transaction Exposure,Hedging techniques include:,Futures hedge,Forward hedge,Money market hedge,and,Currency option hedge.,MNCs will normally compare the cash flows that could be expected from each hedging technique before determining which technique to apply.,A,futures hedge,involves the use of currency futures.,To hedge future payables,the firm may purchase a currency futures contract for the currency that it will be needing.,To hedge future receivables,the firm may sell a currency futures contract for the currency that it will be receiving.,Techniques to Eliminate Transaction Exposure,A,forward hedge,differs from a futures hedge in that forward contracts are used instead of futures contract to lock in the future exchange rate at which the firm will buy or sell a currency.,Recall that forward contracts are common for large transactions,while the standardized futures contracts involve smaller amounts.,Techniques to Eliminate Transaction Exposure,An exposure to exchange rate movements need not necessarily be hedged,despite the ease of futures and forward hedging.,Based on the firms degree of risk aversion,the hedge-versus-no-hedge decision can be made by comparing the known result of hedging to the possible results of remaining unhedged.,Techniques to Eliminate Transaction Exposure,Real cost of hedging payables(RCH,p,),=,+nominal cost of payables with hedging,nominal cost of payables without hedging,Real cost of hedging receivables(RCH,r,),=,+nominal home currency revenues received without hedging,nominal home currency revenues received with hedging,Techniques to Eliminate Transaction Exposure,If the real cost of hedging is negative,then hedging is more favorable than not hedging.,To compute the expected value of the real cost of hedging,first develop a probability distribution for the future spot rate,and then use it to develop a probability distribution for the real cost of hedging.,Techniques to Eliminate Transaction Exposure,Nominal Cost Nominal Cost,Real Cost,Probability With Hedging Without Hedging of Hedging,5%$1.40$1.30$0.10,10$1.40$1.32$0.08,15$1.40$1.34$0.06,20$1.40$1.36$0.04,20$1.40$1.38$0.02,15$1.40$1.40$0.00,10$1.40$1.42-,$0.02,5$1.40$1.45-,$0.05,Expected RCH,p,=,P,i,RCH,i,=$0.0295,The Real Cost of Hedging for Each in Payables,There is a 15%chance that the real cost of hedging will be negative.,The Real Cost of Hedging for Each in Payables,Probability,If the forward rate is an accurate predictor of the future spot rate,the real cost of hedging will be zero.,If the forward rate is an unbiased predictor of the future spot rate,the real cost of hedging will be zero on average.,Techniques to Eliminate Transaction Exposure,The Real Cost of Hedging British Pounds Over Time,RCH(receivables),RCH(payables),A,money market hedge,involves taking one or more money market position to cover a transaction exposure.,Often,two positions are required.,Payables:,Borrow in the home currency,and,invest in the foreign currency.,Receivables:,borrow in the foreign currency,and,invest in the home currency.,Techniques to Eliminate Transaction Exposure,Techniques to Eliminate Transaction Exposure,Effective,exchange rate,$0.6513/NZ$,2.,Holds NZ$995,025,Exchange at$0.6500/NZ$,1.,Borrows$646,766,Borrows at 8.40%,for 30 days,3.,Pays$651,293,3.,Receives NZ$1,000,000,Lends at 6.00%for 30 days,A firm needs to pay NZ$1,000,000 in 30 days.,Techniques to Eliminate Transaction Exposure,Effective,exchange rate,$0.5489/S$,2.,Holds$215,686,Exchange at$0.5500/S$,1.,Borrows S$392,157,Borrows at 8.00%,for 90 days,3.,Pays S$400,000,3.,Receives$219,568,Le
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