Alternative Foreign Currency Hedging Instruments
introduction
Multinational companies that operate through different subsidiaries located in different parts of the world most of the time face risks regarding exchange risk exposures. This is because transnational companies use various monetary denominations that have different values depending on the currency that it will be exchanged with. When presenting regular financial reports, multinational companies are at risks with what denominations to use in order to accurately report the financial achievements of the company in terms of profits and revenues as well as the expenditures and accountabilities of the business in a specific span of time. Since rates differ from time to time and across countries, it is difficult for multinational companies to verify the accomplishments and financial attainments. Management accounting control systems are used to create means of overcoming such financial concerns among international business organizations.
Discussion
Notger (1998) identified the different types of financial risks that depend on the type of financial exposure used by the business organization which include transaction, economic and translation risks. Transaction exposure risks when cash flows are exchange to other monetary denomination which influences the profitability and liquidity value of the assets of the company particularly when the currencies that were exchanged were of different value or worth. Economic exposure risks are evident when there are inevitable changes due to fluctuation of rates that directly influence the market share and profit margins of the company. Finally, translation exposure risks arise from creating financial reports that include all the accounts of all the operating subsidiaries of a business organization highlighting the difficulties of balancing the accounts into a single monetary denomination (Notger, 1998). All these risks are detrimental to the present as well as the future value or worth of a particular business organization.
According to Joseph (2002) exchange rate exposures take into account the value or worth of a firm a well as an industry as affected by the changes in exchange rates. The risks associated with foreign exchange are extensive in nature because investors most of the time own different portfolios characterized with different securities in various currencies. Multinational companies and their subsidiaries that make use of monies in different denominations are likewise highly affected by exposure risks along with importers and exporters who supply materials and services at different monetary values. Exchange rate exposure also operate during procurement processes in which the worth and value of input materials are differentiated from the worth of the output or produced goods. The costs incurred for the inputs should be balanced with the value of the output when sold at different currencies. All these put a business organizations competitive position relatively in terms of international financial management concerns (Joseph, 2002).
It was highlighted by Amit and Wernerfelt (1990) that it is normally the case that business organizations are advised to bill in the domestic currency which eliminated exchange rate exposures. But despite the absence of transaction exposure risk when billing at the domestic currency market risks on the other hand are present (Amit & Wernerfelt, 1990). In this regard, the influence and impact of exchange rate exposure risks affect every individual who owns money. In every monetary transaction activity that a person is involved in, the influence of exposure risks can not be denied nor should e neglected. This has been the common practice among business organizations operating in the international market economies. Hence, to emerge successful, business organizations need to be sensitive both in the theoretical and practical domains of business management in taking into account the economic factors and indicators. Company policies in this regard should be reviewed.
According to Makin (1978) any change in the foreign exchange rates affects the value or worth of a business firm or an industry. Multinational companies face extensive risks because different currency denominations make possible the international operations of the business organization which determine if the company’s assets will have an increased or a decreased monetary value. But modern financial management theories are emphasizing that concerns regarding exchange rate exposures should not concern business entities in the international market because they deem such concerns are irrelevant and illegitimate. This is mainly due to the fact that hedging tools are readily available for the use of investors and stockholders of companies. Moreover, the Modigliani-Miller Theorem indicates that business organizations are not capable of manipulating the shareholder value of the company (Makin, 1978).
Hedging tools are used by business organizations operating internationally in order to minimize the effect of exchange rate exposure risks to the value and accomplishments of the company. These hedging tools serve as the business organizations’ management accounting control system when it comes to concerns regarding the financial aspects of the company. According to Modigliani and Miller (1958) financial policies among corporations particularly those that deal with foreign exchange risk exposures without transaction costs and taxes are irrelevant because investors are capable to withdrawing stock investments anytime they want. Logue and Sweeney (1977) agreed because they believe that translation exposures are only beneficial during accounting an because the changing values of currencies has no effect on the real economic value of the assets of the company (Logue & Sweeney, 1977).
Reference
Joseph, NL 2002, ‘Modelling the impacts of interest rate and exchange rate changes on UK stock returns’, Derivatives Use, Trading and Regulation vol. 7, pp. 306-323.
Logue, D & Sweeney, RJ 1977, ‘White-noise in imperfect markets: The case of of the franc/dollar exchanger rate’, The Journal of Finance, vol. 32, no. 3, pp. 761-768.
Makin, JH 1978, ‘Portfolio Theory and the Problem of Foreign Exchange Risks’, Journal of Finance, pp. 517-534.
Notger, N 1998, ‘Managing Foreign Exchange Risk, First Draft’, FH Wurzburg University of Applied Science, pp. 47-49
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