In: Business and Management

Submitted By karthikrdy
Words 3106
Pages 13
Why should we hedge?

Business is exposed to several risks, currency risk being one of them

Objective of hedging is to ensure:

Predictability in Income Statement thereby reducing cash flow volatility.

Revenue is generated & receivables are collected at budgeted rates

Maintaining margins on long term projects as these projects are priced & bid with an exchange rate assumption, which needs to be protected to ensure desired margins

Managing the translation risks in case of multiple geographies & overseas entities

Best Practices

A good risk management and hedging policy should be debated, understood & approved at the highest level (Board)

The policy should indentify risks entity is exposed to, ways to measure these risks & suggest methods to mitigate these risks

Should specify clear identification of responsibilities, authorities & limitations on its implementation

Should state the purpose of hedging clearly - profit, protection, reducing volatility.

Should suggest appropriate risk management tools like Sensitivity Analysis, VAR to contain risks

Should be reviewed periodically by board in view of changing risks, market dynamics.

Enctheirage use of natural hedges to reduce hedging costs


Methods of hedging can be classified as

a. Internal methods

b. External methods

1. Internal methods: Internal methods include:

i. Invoicing: In invoicing the corporate shifts the entire exchange risk to the other party by insisting that all its imports and exports be invoiced in its home currency.

ii. Netting/matching of cash flows: In this method of hedging if a firm has receivables and payables corresponding to the same periods then even if…...

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