Answers
If not what will be the consequences?
If so how should they decide which exposure to hedge
They generally should hedge currency risk. If not, the risk is that gains realized in the foreign currency will be erased by decreases in the value of the foreign currency as measured against your home currency.
The example on wikipedia is:
For example if you are a U.S. investor and you have stocks in Canada, the return that you will realize is affected by both the change in the price of the stocks and the change of the Canadian dollar against the U.S. dollar. Suppose that you realized a return in the stocks of 15% but if the Canadian dollar depreciated 15% against the U.S. dollar, you would realize no gain.
Another possible risk, for importers and exporters, is that currency fluctuations will change the relative prices of foreign and domestic goods, making foreign products more or less attractive.
Yesterday I reviews Saunders' un-hedged bank: $200 million in US dollar deposits fund investments which are split (50%/50%) between US dollar ...
How do they do it . ?
All (major) airlines do fuel hedging. It's basically very simple: they buy fuel that will be delivered in the future (next month, next year) at a predetermined price. If the price increases they make a profit on it, if the price decreases they are loosing money.
Hedging allow to predict the operating costs and takes away part of the risk associated with the wrong price. It can be done by buying options (the right to buy or sell at the predetermined price in the future) or by buying futures (the duty of buy or sell at a predetermined price in the future).
and what is the best way for a multinational corporation to hedge against foreign currency risk?
Currency risks can affect firms in a multitude of ways.
The most common problem is the potential mismatch in what they receive revenues in and what they payout in expenses.
Example: US multinational sells goods in Europe. It gets paid in euros but all expenses are US dollar denominated. In that case if the dollar strengthens, the euro revenues generated are worth less (you get less dollars back than before on conversion) reducing margins. The reverse could happen (US dollar weakens) which would be a benefit.
The example also illustrates a second slightly more subtle problem. Dollar strength could make a company less competitive worldwide. So not only do you make less it may make substitutes cheaper.
Example: Same as above. But also imagine Euro multinational which makes the same good. Because the US dollar is strong it makes the good relatively expensive so it might lose sales to Euro multination whose goods look cheaper. So not only is there margin loss, but there is potential for loss of market share.
Another potential risk in certain countries is just lack of free exchange. It's difficult to convert money in that country's currency back into US dollars (or other home currency). The greatest example of that is Venezuela.
So how do firms manage foreign currency risk? You could engage in foreign currency hedging that would offset the cross currency exposure. You could operationally hedge. In the above example, US multinational could build a factory in Europe. Then it's costs would be locally denominated and so the relative differences in cost structure caused by currency fluctuations would be controlled. US multinational could further hedge by borrowing money in euros. Thus if US dollar strengthens hurting margins and market share, the value of their euro debt would also go down in dollar terms (they would owe less money).
a) business risk
b) financial risk
c) political risk
d) exchange rate risk
e) all of the above
All of the above.
Daily Foreign Exchange Market Summary 23/10/2009
The US dollar rose against sterling and yen after a survey showed sales of existing US homes last month at a two-year high, providing evidence the housing market is on the mend. Purchases jumped 9.4 percent to a 5.57 million annual rate, more than forecast and following a 5.09 rate in August. The greenback rallied against sterling mostly on disappointing UK data showing the UK economy is still mired in recession. The US dollar had been sliding across the board all week on expectations that US interest rates will remain low for some time.
The euro also vaulted higher against the US dollar and pound on generally upbeat euro- zone data, underlining expectations of a recovery in the third quarter and kept it near a 14-month peak above $1.50. The single currency drew support from the Ifo index of German business morale that showed the bloc's economic recovery to be generally on track.
Sterling extended its sharp fall in the wake of data showing UK unexpectedly contracted in the third quarter, dropping below a key technical support level against the US dollar. The pound has been under heavy pressure since data showed UK GDP fell by 0.4 percent between July and September, way below analysts' expectations of a 0.2 percent rise.
Operational Hedging and Exchange Rate Risk: A Cross-sectional ...
Managerial Review:
Rather than catch in high-priced and elaborate currency hedging, hotels operating in an worldwide atmosphere can earnings correspond to benefits from their usual operations, including net income directors. An criticism of 1,032 Canadian hotels over a full stop of over two and one-half years shows that due to exhange rate interactions, ADR, occupancy, and RevPAR further in ineffective currency environments, while they decline in definite environments. As a district currency fluctuates in in-law to the dollar, euro, or yen, changes in ADR, occupancy, and (thus) RevPAR nullify losses from currency movement in chicken-hearted environments and diminish gains when the currency is garish. When a townsperson currency loses value against the dollar, for occurrence, travelers judge hotels priced in that currency to be less costly, even though the puppet appraisal hasn’t changed. Additional travelers who are attracted by "anticipate" prices further occupancy and reason the guest-house’s proceeds governance system to endorse higher rates. Even with higher rates, the hotel’s rates might still be favorable, and the caravanserai’s returns per handy space would be augmented by both higher chamber rates and higher occupancy. The connection is that multinational lodging chains have significantly less revelation to foreign exchange risk than implied by usual hedging practices.
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Charles Chang, Ph.D., joined the Inn Educational institution at Cornell University in 2003 upon receiving a Ph.D. in underwrite from the Haas Concern Opinion at the University of California, Berkeley. Late to that, he was a decorated book-woman at the Wharton Kindergarten of Subject, University of Pennsylvania. He is actively preoccupied in into in the fields of investments, institutional trading, and behavioral cash with a convergence on emerging markets. He has presented findings at some of the most impressive conferences in the entrants and has published drudgery in top journals such as the Fortnightly of Monetary Economics, the Quarterly of Corporate Commerce, and the Periodical of Global On Easy Street and Subsidize. Since 2003, he has acted as managing buddy for PM Legacy Ripsnorting, a privately held investment consulting article that has managed funds and provided investment consulting services for clients in the U.S. and far.
...News
BOC: Intervention in Foreign-Exchange Market 'An Option'Wall Street Journal - Oct 22, 2009
CBC.caBOC: Intervention in Foreign-Exchange Market 'An Option' medium-term risk to the outlook for Canada and globally and there will have to be "further adjustments to structural monetary and exchange rate policies CANADA FX DEBT-C$ lower as BoC warnings on strength lingerCanada's Currency Trades Near 15-Month High on Parity WagersBank of Canada sees economy recovering, loonie risks - -all 1,271 news articles »
International Business Times - Oct 23, 2009
MiamiHerald.comPurchases jumped 9.4 percent to a 5.57 million annual rate, more than forecast and following a 5.09 rate in August. The greenback rallied against sterling SENTIMENT SHIFT HELPS DOLLAR RALLYDaily Foreign Exchange Market Summary 22/10/2009all 281 news articles »
ChinaStakes.com - Oct 20, 2009
 (9) US dollar is the main settlement currency in international trade, and US companies don't need to bear the exchange rate risk. (10) The dollar's status and more »Business Mirror - Oct 25, 2009
But he gave assurances that while their presence may be felt at the market from time to time, the exchange rate of the peso relative to the US dollar will and more »The Hindu - Oct 24, 2009
He argues that the more flexible the exchange rate regime, the keener will be the incentives for agents to undertake appropriate foreign exchange risk