1 Hedging Introduction In international transactions, companies often find themselves in situations where they face and increase the risk of foreign exchange exposure. A hedge is an instrument that is used to minimize an organization’s exposure to adverse currency or price fluctuations. Hedging strategies also facilitate the protection of an organization's income streams and to reduce its expenses. Hedging allows an organization to plan its finances better. In essence, hedging acts like an insurance system because it protects an organization’s future cash-flows. Importance of Hedging A hedge protects one's finances from situations that have the potential to devalue its assets. Using hedging instruments, the company secures itself against price changes and currency fluctuations, which may affect the value of the business negatively (Petty et al., 2015). Hedging locks in a price which provides a guarantee of the stability of the organization’s current and future cash flows enables the company to obtain a more accurate calculation of the property’s purchase price and reduce the instability of the firm’s cash position through minimizing its risk exposure. Buy this excellently written paper or order a fresh one from ace-myhomework.com
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Nodal Logistics Corporation (NLC), a multinational Real Estate Investment Trust (REIT) intends to expand its asset portfolio by acquiring a property in Brazil. In its various investments across the world, Nodal has only transacted in US dollars; therefore, it has no prior experience in hedging. However, Brazilian law requires that commercial real estate contracts be denominated in Brazilian reals. John did not have significant experience in hedging since the company had no prior experience in transactions that exposed it to currency risks. In this situation, Nodal has three options. Firstly, it could choose to accept the risk and proceed with its purchase of the Brazilian property without protecting itself against it. However, this option is very risky because the Brazilian currency is prone to fluctuation, and in recent years, has been consistently appreciating against the dollar (Eichengreen, & Woods, 2016). The appreciation of the real was driven by an increase in foreign direct investment, sound economic policy, and low macro volatility. Hedging Strategies The US dollar has been the primary operating currency for Nodal, and its transaction with Brazil will result in a strong foreign currency risk exposure. The first hedging option available to Nodal is forward contracts. Under this strategy, the company would be able to lock the current exchange rate between the real and the dollar. This is one of the most viable options for Nodal because the Brazilian currency is projected to continue strengthening against the dollar; therefore, this would protect it against future losses. The second hedging strategy available to Nodal is currency options, and specifically, put options. This would allow the company to protect itself from losses in case the real
3 appreciated, and also provide flexibility in the event that the dollar strengthened against the real. The third strategy that Nodal could use is a Currency Adjustment Clause (CAC). In this strategy, the two parties involved in the transaction agree to share the fluctuation of the exchange rate (Cheng et al., 2014). The cooperation between the buyer and seller is beneficial to both parties because it eliminates the situation where one party gains and the other loses. The fourth hedging strategy available to the company is local currency debt financing, where Nodal will use the local currency – the real – as a partial hedging instrument. This involves funding the project partially using local currency debt; the debt will be repaid through the local currency earnings. Out of the four hedging options available, the most effective strategy for Nodal is hedging with put options. The main merit of using put options is that it offers protections against adverse price fluctuations, thus protecting the company’s cash flows and assets. This strategy also has the potential to allow the company to reap from the strengthening of its currency. Southwest Airlines Fuel Hedging Strategy For several years, the price of jet fuel has continuously been rising, reducing the margins and in some cases leading to losses for airlines such as Southwest Airlines. A hedging strategy is a crucial tool to guard the company against escalating fuel costs (Bekaert, & Hodrick, 2017). To implement the most effective hedging strategy, Southwest Airlines must understand the challenges and complexities of not only fuel price management, but also the management of foreign exchange and interest rate fluctuations. The most important objective for the airline is to maximize its shareholders’ wealth. Conclusion
4 Multinational organizations, regardless of the industry in which they operate, can use a variety of hedging tactics to manage their exposure to the risk of foreign exchange fluctuation. An appropriate hedging strategy is used depending on the challenge that the multinational seeks to address; in some cases, it is translation exposure, operational exposure, while in others, it could be transactional exposure. In Nodal’s purchase of the Brazilian property, the firm encounters a strong foreign currency exposure, which it can protect itself against using put options. Managing foreign currency risk involves performing a thorough analysis of the organization's exposure and making tough decisions to eliminate or reduce the negative consequences of the transaction.
5 References Bekaert, G., & Hodrick, R. (2017). International financial management. Cambridge University Press. Cheng et al. (2014). The international integrated reporting framework: key issues and future research opportunities. Journal of International Financial Management & Accounting, 25(1), 90-119. Eichengreen, B., & Woods, N. (2016). The IMF's Unmet Challenges. Journal of Economic Perspectives, Volume 30(1), 29-52. Petty et al. (2015). Financial management: Principles and applications. Pearson Higher Education AU.