Link Technologies Case Report

2) Minimize the cost associated with the foreign exchange risk management strategy, i.e. the management and hedging costs

One way to avoid over-hedging is to hedge only the minimum known payment involved in the future transaction. By hedging a portion of the transactions, a company can reduce the sensitivity of its cash flows to exchange rate movements without creating serious mismatches between the hedge and the risk. In this way, ERM — which consists of managers taking a holistic view of their company’s various risks, prioritizing the material ones, and devising ways to curb them — can help CFOs identify the most volatile foreign exchange rates and reduce some of the guesswork involved in deciding how much of their foreign exchange risk to hedge.

Nestlé S.A. is a Swiss company and owns a prestigious position being the world’s leading nutrition, health and wellness group (Nestlé, 2016). According to its annual report (2015), this company is exposed to many risks caused by movements in foreign currency exchange rates, interest rate and market prices. The foreign exchange risk comes from transactions and translations of foreign operations in Swiss Francs (CHF). The interest rate risk faces the borrowings at fixed and variable rates. The market price risk comes from commodity price and equity price. The former risk arises from world commodity market for the supplies of coffee, cocoa beans, sugar and others. The later risk arises from the fluctuations of the prices of investments held. (Nestle annual reports, 2015). Thus, financial derivatives instruments are used by this multinational corporation in order to hedge these risks.

Good management skills were proved to be an essential factor in the survival of the hedge fund in the decades to come. Many leveraged long, in particularly risky and uncooperative markets, which led to only 68 identifiable hedge funds in 1984. However, as new ideas were developed, such as investing in the currency markets or using futures and options,

In 1949 Alfred Jones created the first hedge fund in the United States with $100,000 and a strategy to off set the riskiness of holding long position in stocks by shorting other stocks. Since then hedge funds have grown to control over $2.4 trillion in assets in over 11,000 different funds. Today hedge funds employ many different techniques and strategies to gain a positive return that actually do not involve hedging but instead taking a more risky stance in the market to obtain higher returns. Hedge funds are predominately funded by wealthy investors and pensions but does this mean that they are a safe investment to make? If I had the ability to invest in a hedge fund I would decline to do so. My reasoning for this is that while some risky investors believe the high risk high return, lack of regulation, illiquidity, and fees associated are the advantages of hedge funds that allow them to generate high returns, from a conservative investor viewpoint these are all disadvantages and risks that aren’t compensated for making investments in hedge funds an unwise decision.

Hedging did achieve – 1) Ability to continue investing in positive NPV projects – For car manufacturers there is a constant need to finance R&D for new products (cars) and CAPX (investment in PPE). See exhibit 3 which shows how Jaguar CAPX + R&D was greater than operating profit in 4/5 years between 84-88. Given that accessing capital markets (to finance such cash outflows is difficult and expensive) the hedging program was a may have been a good decisions if served to limit the volatility of revenues -> operating profit -> cashflows from operations -> ability to continue investing. 2) Tax benefits (smoothing of earnings in progressive tax environment) – The earnings of Jaguar are relatively stable across the period, meaning that taxes payments may have been less than would have been the case without the hedging.

There is a long list of papers in the literature focusing on the relationship between managers ability to hedge and firms risk. As such, these studies, among others, have documented a number of techniques that executives use to hedge their undiversified portfolios, such as the use of low-cost collars

What is hedging? Hedging is a strategy used to protect risks posed by worldwide currency fluctuations. One hedges the currency risk by contracting to sell foreign currency in the future, at the current exchange rate (Fries). If fund managers think the dollar is going to be stronger when they are ready to change the foreign currency back into American dollars, then they take out a foreign futures contract (a hedge). Thus, they lock in the exchange rate beforehand, so that they will not lose profits gained from holding devalued foreign currency (Hedging, 1999). If the manager guesses correctly, he will boost the fund 's overall return because the profits will be worth even more when they are exchanged into American dollars.

We will extend our findings about undercapitalization in Table 4 based on our conclusions from Table 3. From Table 3, we know that there are 222 undercapitalized live hedge funds, and it consists only 8.1% of all the live funds. From this we can reach the conclusion that only a small fraction of live hedge funds are undercapitalized. Most of the live hedge funds (about 91.9%) can stay out of the risk of being undercapitalized. While the undercapitalized ratio for dead funds is 12.3%, so more dead funds are undercapitalized compared with the ratio of live funds. Since the ratio of undercapitalization plays an important role in determining the performance of a hedge fund, we will take a further look into the details of undercapitalization in Table 4. We list a number of variables that would usually have influence on the cap ratio. By comparing the different variable values under the category of adequately capitalized funds and under-capitalized funds, we can determine the key elements that would usually influence the cap ratio of a hedge fund. Table 4 also illustrates the comparative characteristics between live and dead hedge funds. We can specify the characteristics in the following points. First, the mean of the net asset for the undercapitalized live funds is $88.4 million and the corresponding value for the capitalized funds is $206.1 million. The huge difference between these two values means a positive condition in the capital adequacy of the live funds. More live hedge

Note that a company might do better if it chooses not to hedge than if it chooses to hedge. Alternatively, it might do worse. Consider ImportCo. If the exchange rate is 1.7000 on October 14 and the company has not hedged, the £10 million that it has to pay will cost $17,000,000, which is less than $18,405,000. On the other hand, if the exchange rate is 1.9000, the £10 million will cost $19,000,000Ðand the company will wish it had hedged! The position of ExportCo if it does not hedge is the reverse. If the exchange rate in September proves to be less than 1.8400, the company will wish it had hedged; if the rate is greater than 1.8400, it will be pleased it has not done so. This example illustrates a key aspect of hedging. Hedging reduces the risk, but it is not necessarily the case that the outcome with hedging will be better than the outcome without hedging.

This report is based on a practical scenario solution of General motors. The report addresses the problem given in scenario which is the change in policy of hedging with detailed reasoning. The report then looks at the different available hedging instruments to the firm. Profitability of both instruments has been compared and lowest cost option was selected to mitigate the transactional risk. Translation risk has also been seen at different hedging ratio levels; current one and the proposed one. The options were more profitable to the firm that has been recommended. Argentinean subsidiary’s

Hedging can be defined as a risk management mechanism or strategy which is used to prevent the chances of incurring losses which arise as a result of fall in prices commodities or currencies. It is a technique which is majorly used by the investors in protecting their capital against the effects of the economic situations such as inflation whereby the investors invests in the high yield financial instruments or take a position to cushion them against such effects (Investopedia, 2012).

Q.1 Why does Porsche hedge its foreign exchange exposure? Does it make sense from the perspective of shareholders, for Porche to hedge? Does it make sense from management’s perspective? Are there potential differences in interest between management and shareholders regarding the hedging policy?

According to Advantages and Disadvantages of Hedging in Finance (n.d.), it mentioned the purpose of hedging is to get protection against market risk and it is commonly used by companies that are related with certain markets especially commodities and interest rate. However, hedging may sometime cause the companies to lose their opportunities such as the fall in the energy prices in previous years will cause the hedged airlines to not gain the benefits as much as the unhedged. Besides, hedging maybe costly even the market always remain stable such as insurance products which usually require upfront payment. Moreover, the risk seeking investors may not like the companies that have hedges.

A strategy of risk management is known as hedging. It limits or offsets probability of loss caused by fluctuations in the price of commodities, currencies, or securities. Consequently, hedging is a transfer of risk without the need of buying insurance policies. Hedging uses various methods.