Non-financial companies that deal with exchange rates have two strategic choices to safeguard against currency risks: currency hedging and strategic hedging. The former involves the use of forward transactions, which necessitates some expectations or forecasts of future rates. Strategic hedging, meanwhile, entails the spreading out of a firm’s activities in a number of different currency zones in order to offset losses in any one zone. While currency hedging can largely be performed by a small group of experts, strategic hedging requires communication across various divisions, including marketing, sourcing, production, and finance.
As the executive of a manufacturing firm that receives supplies from 18 different countries and sells products to 24 countries, your success and failure is determined by exchange rates, which cause frequent fluctuations in the price of supplies and the sale price of manufactured goods. Considering both the pros and cons of currency hedging and strategic hedging, which strategy would you opt for? How would you justify this decision to other executives and to shareholders?
Can you please answer this with 400-450 words so I can see for myself how to understand this? thanks.
For a large company which procures from 18 countries and sells its
products to 24 different countries, the scale of business is quite
large and currency fluctuations could impact the bottom line in a
big manner.
Since, the procurement of raw material and sale of finished goods happens across geographies and the transactions takes place in different currencies, some of which appreciates or depreciates against the currency in which the financial reporting is being done, so there exist a natural hedge in the operations of the company. Hence, this natural advantage should be further cultivated and diversification of procurement and revenue sources should be promoted via marketing efforts.
Post the above steps, an evaluation of the residual risks should be done to assess the risks which still remains even post the strategic hedging being implemented. To mitigate the residual risks, currency hedging using currency forwards/futures or options should be undertaken to completely minimize the impact of currency volatility on the organization’s P&L statement. Since, currency hedging using financial instruments entails payment of a premium to buy these instruments and mitigate the risks, undertaking financial hedging should be done to reduce the residual risks only and should be a secondary step post the primary tactic of strategic hedging.
Thus, a combination of strategic hedging and financial hedging should be used to reduce risk currency volatility and also reduce the costs of the hedging.
Non-financial companies that deal with exchange rates have two strategic choices to safeguard against currency risks:...
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