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 .
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