Hedging Strategies

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1. INTRODUCTION “HEDGE” A hedge is a position to minimize unwanted risk or to manage operating and transaction exposure. The goal is to compensate the loss in value of one item with the increase in value of the offsetting item. There are different reasons for hedging a position; first of all, the price increase and the fluctuation of price are volatile. Secondly, every company should have a fixed calculation basis or price basis to plan a short and long-term horizon. If not every buyer of a company does not know how to deal with the budget. Furthermore, there are a lot of different possibilities to hedge a position, but the easiest way is hedging with complete specific financial vehicles. Without hedging is business nowadays impossible…show more content…
It just minimizes the risk of the exposure to currency risk and its impact on future cash flows and as these two positions are not perfectly correlated the risk cannot be hedged perfect. 4.1 ADVANTAGE There are some advantages by hedging through the financial markets. First of all, the firm could control the profit risk over a transfer of risk to customers. Furthermore, they could sell risk in to risk-sharing markets with high returns. Secondly, the costs of buying and selling financial instruments are low compared to the costs of investing in real assets. However, the financial market transactions are likely zero NPV and so there is no change in the firms operations. Another aspect is the diversification of the fluctuation prices, which reflect a noticeable price basis to plan in long-term horizon. 4.2 DISADVANTAGE The most important disadvantage is that the financial market hedge never can completely hedge operating exposure. In addition, financial market hedge do not match the uncertain cash flows of an operating exposure. The uncertain cash flows of firm’s real assets cannot be fully hedged by financial instruments. Furthermore, the financial market hedge does not reduce the operating exposure itself, because in reality it is the transaction exposure - the company could reflect the series of consecutive short-term options as operating exposure. These
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