Introduction of hedging

What is Hedging ???

Advanced

investing

strategy

Reducing and

controlling risk

Gain or loss in cash

position

Hedging ConceptRisk offsetting toolSimilar to insurance Negative event cannot be prevented Not to make money but reduce

loses Its may help smooth income and

minimize tax liability Its may help smooth income and

reduce managerial salaries

Categories of hedgeable risk Commodity risk Rising and falling com. Prices which result in demand and supply imbalance

Credit risk Money owing will not paid by obligor .

Currency risk Financial transaction is denominated in a currency other than base currency of a company

Volatility Risk Increased price fluctuations in market places.

Volumetric Risk Customer demand more or less of a product than expected.

Interest Rate Risk Arises for bond owners from fluctuating interest rate.

Equity Risk Involved in holding equity in a particular investment

Limitations Of Hedging

Limitations Of Hedging An Uncertain Amount

Overhedging a large amount in a currency than the actual transaction amount .

Adversely affect a firm . To avoid this MNCs cannot

completely hedge all of their transactions.

Reduce the sensitivity of their cash flows to exchange rate movements.

Limitations Of Repeated Short Term Hedging Repeated transactions are

expected to occur in near future has limited effectiveness over the long run .

Short futures hedge appropriate when you will sell an asset in the future and fear a fall in price .

Some MNCs more focus on hedging receivables or payables that will occur in the near future .