Page 119 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes hedging decision. For example, after 45 or 60 days, it should repeat the analysis, based on
the applicable spot rate, forward rate, interest rates, call option information, and forecasts
of the spot rate 120 days in the future (when the payable are due.)
Question
Make suggestion to DC Corporation on their hedging decision. (Hint: After comparing all
the available hedging option the forward option is looking better. On the other hand
company can go with no hedge strategy. Another option is that company can review the
hedging decision in the mid term.
Source: International Financial Management, Madhu Vij, Excel Books.
7.6 Summary

The unit focuses on the measurement and management of transaction exposure.
Transaction exposure measures gains or losses that arise from the settlement of existing
financial obligations whose terms are stated in a foreign currency.

Transaction exposure can be hedged by financial contracts like forward, money market
and option contracts as well as by other operational techniques like lead/lag strategy and
exposure netting.

Transaction exposure measures the effect of an exchange rate change on outstanding
obligations which existed before exchange rates changed but were settled after the exchange
rate changes.
Transaction exposure thus deals with changes in cash flows that result from existing
contractual obligations.

This unit analyses how transaction exposure is measured and managed.
A primary objective of this unit is to provide an overview of hedging techniques.
Yet, transaction exposure cannot always be hedged in all cases. Even when it can be
hedged, the firm must decide whether a hedge is feasible or not; generally firm comes to
know whether hedging is worthwhile or not after a certain period of time.

7.7 Keywords

Call Option: Call option is the right, but not the obligation, to buy a foreign currency at a
specified price, upto the expiration date.
Currency Correlations: The degree of simultaneous movements of two or more currencies with
respect to some base currency.
Currency Volatility: The volatility of a currency is a measure of the change in price over a given
time period.

Exposure Netting: Exposure netting involves offsetting exposures in one currency with exposures
in the same or another currency, where exchange rates are expected to move in such a way that
losses (gains) on the first exposed position should be offset by gains (losses) on the second
currency exposure.
Money Market Hedge: A Money Market Hedge involves simultaneous borrowing and lending
activities in two different currencies.
Put Option: Put option gives the buyer the right, but not the obligation, to sell a specified
number of foreign currency units to the option seller at a fixed price up to the option’s expiration
date.

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