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Hedging Currency Exchange Rate Risks

Hedging Currency Exchange Rate Risks. Currency Exchange Risk. Cash Inflow in one Currency is Higher or Lower than Corresponding Cash Outflow in Different Currency = Currency Exchange Rate Risk. Types of Currency Exposure. Transaction exposure:

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Hedging Currency Exchange Rate Risks

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  1. Hedging Currency Exchange Rate Risks

  2. Currency Exchange Risk Cash Inflow in one Currency is Higher or Lower than Corresponding Cash Outflow in Different Currency = Currency Exchange Rate Risk

  3. Types of Currency Exposure Transaction exposure: Occurs when a one time contract is denominated in a foreign currency (example: GM buys a new machine in Germany for Detroit factory) Translation exposure: Occurs when of financial statements must be consolidated Operating (Economic) exposure: Occurs when cash inflow (outflow) exceeds cash outflow (inflow) in a different currency as a result of ongoing business activities (example: GM exports cars produced in Detroit to Canada)

  4. 1. Short Term Hedging ( 18 Month) Transaction Exposure Lock in Currency Exchange Rate through the Use of Financial Instruments - Forward Contract - Futures Contract - Option Contract Hedging Currency Exchange Risk

  5. 2. Long Term Hedging Close Gap of Cash Flows in Different Currencies • Direct Investment • Finance Operation in Foreign Currency Financial Instruments Can only Eliminate Short Term Fluctuations, They Can NOT Eliminate the Currency Exchange Rate Risk for Ongoing Business Operations (operating exposure).

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