– Management of a company’s foreign exchange exposure must comprehend the net exposure in each currency based upon a detailed comprehension of all monetary accounts.
– Some counter-arguments to hedging exchange exposure are:
- Real assets in other countries will experience nominal increases in value as inflation increases and exchange rates move down in that currency.
- There are significant transaction costs to hedging.
– Much of the complexity in deciding on and tracking the results of hedging is amenable to automation.
– A newer security is the foreign exchange option. Allows the holder to sell (buy) foreign currency in the future, but also allows the holder to choose not to.
– The cost of options are usually higher than a simple forward contract since the seller has weighed very carefully the odds of losing money upon the options exercise.
– The purpose of the transaction plays a role; a forward contract to sell cash hedges exchange risk exactly, whereas an option actually creates a position that insures against a bad turn in exchange rates but retains the advantage of a beneficial movement.
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