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Management of Transaction Exposure - Coggle Diagram
Management of Transaction
Exposure
Three types of Exposure :
Economic exposure:
Translation exposure:
Transaction exposure:
Forward Market Hedge
Gain = (F − ST) × the amount of hedging currency
3.Money Market Hedge
To hedge the firm’s foreign currency receivables → the firm may borrow in foreign currency
To hedge the firm’s foreign currency payables → the firm may lend in foreign currency
4.Option Market Hedge
the firm may buy a foreign currency call (put) option to hedge its foreign currency payables (receivables).
Hedging Foreign
Currency Payables
Hedging is accomplished by purchasing an offsetting currency exposure.
Cross-hedging Minor
Currency Exposure
Cross hedging refers to the practice of hedging risk using two distinct assets with positively correlated price movements.
Hedging Contingent Exposure
Contingent exposure refers to a situation in which the firm may or may not be subject to
exchange exposure.
A deal-contingent hedge is a hedging arrangement that is signed before closing on a financing transaction and does not take effect until the transaction closes.
Hedging recurrent with Swap contract
Hedging through Invoice Currency
(1) Shift exchange rate risk
(2) Share exchange rate risk
(3) Diversify exchange rate risk
(3) Diversify exchange rate risk
If a currency is appreciating, pay those bills denominated in that currency early; let
customers in that country pay late as long as they are paying in that currency.
Should the firm Hedge?
Differential Transactions Costs: The firm may be able to hedge at better prices than the
shareholders.
Default Costs: Hedging may reduce the firms cost of capital if it reduces the probability of
default.
Information Asymmetry : The managers may have better information than the shareholders.
Progressive corporate taxes: Stable before-tax earnings lead to lower corporate taxes than volatile earnings with the same average value. This happens because under progressive tax rates, the firm pays more taxes in high-earning periods than it saves in low-earning periods.
What risk management products do firms use?
In the financial world, risk management is the process of identification, analysis, and acceptance or mitigation of uncertainty in investment decisions.