Finance Essay examples
The purpose of this paper is to examine if “Currency Hedging at firm level adds share-holder values”. A lot of papers have been written based on this sentence and there are many opinions that have been vented through of these researches. In a perfect world, according to Modigliani and Miller theorem, there is no reason to hedge because hedging does not add value to the firm. So, when there is not asymmetric information, taxes and transaction cost risk management is irrelevant to firms. On the other hand, we have a number of studies that support that the currency hedging is positively related to the increase of shareholder value. Allayannis and Weston (2001) using U.S. data from 720 firms found that hedging boost firm value, …show more content…
The most important mission of a manager is to evaluate and to control the foreign exchange exposure so that to maximize the profitability, cash flows and market value of the firm.
In order to achieve it, managers use foreign currency derivatives. The main three common derivatives are foreign currency forwards, futures and options.
Foreign currency forwards are traded over the counter and involve a forward contract and funds to complete that contract. Foreign currency futures are traded on organized exchanges and they give the obligation to the holder to make a delivery of a standard amount of foreign exchange at fixed time, place and price. Foreign currency option is a contract that gives the holder the right, but not the obligation, to buy or sell an amount of foreign exchange for a fixed price per unit until the maturity date.
Using these foreign currency derivatives managers try to deal with the three kinds of FX exposure: a) transaction exposure that measures profits or losses that arise from transactions in different currency than the home currency, b) operating exposure that measures changes in futures cash flows arising from unexpected changes in exchange rates and c) translation exposure that measures changes in the accounting reports of the firm because of conversion of foreign currency financial statement of subsidiaries into home currency.