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Using Linear And Non Linear Derivatives

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Nowadays, hedge become a significant element, which may determine the success of a business, to most of the multinational corporations. To form a value maximizing hedging strategy, which is to identify the appropriate mix of linear and non-linear derivatives, turn into a major challenge towards corporate risk managers. The article explains several questions about a multinational corporation’s strategy in choosing and mixing the hedging instruments. For instance, why do most firms use mainly linear derivatives; why do a substantially smaller number of firms use only non-linear instruments; and what factors influence the use of linear or non-linear or the combination of the two derivatives. The researchers testified that the external and internal of a company’s business risk are the key factor towards the use of these two types of hedging instruments. In the practice, companies face multiple business risk, which include price uncertainty and quantity uncertainty. In order to reduce the dispersion of operating cash flows, managers have to contend with two risk sources, the price risk and the quantity risk. As quantity and price risk increase, it is more likely that the firm would experience “over-hedging” costs from a strategy of matching a linear hedging position to an expected exposure level. Managers should reduce the linear hedging position and substituted to some non-linear contracts. The authors illustrate the fact by providing a numerical business
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