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Hedging Strategy and Foreign Exchange Risks

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1. What is the basic translation hedging strategy? How does it work?

2. MNCs can always reduce the foreign exchange risk faced by their foreign affiliates by borrowing in the local currency. True or false? Why?

3. Explain why FASB 133 is 'one of the most complex FASB standards'.

Please explain in detail.

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The Basic Translation Hedging Strategy:

In diverse organizations there are separate types of the exchange rate risks faced. They include; transactional, translation and economic risk. To reduce these risks and give the corporation the opportunity to undertake their operations with ease, elements of exchange rate risk management should be considered by the organization. One of those elements is the basic translation hedging strategy. International corporations encounter a lot challenges as they cut through national boundaries to offer their services and commodities to their target market. The exposure to exchange rates variations are mitigated through the use of this basic translation hedging strategy. To allow these international organizations as well as others to have effective management of their transactions and translation risks, the companies the basic translation strategy is put in place (Jacque, 2011).

Contrary to the great employment of the basic translation strategy, their other organizations that do not utilized this strategy. The reason for this is due to; the long term investments nature in subsidiaries, the zero-sum nature that has been perceived of the current risk above the long term, impact of the cash flow and the accounting issues that are faced by the organization.

Benefits of the Strategy:

Through the basic management of the exchange rate risks ...

Solution Summary

This solution discusses basic translation hedging strategy, whether MNCs can reduce the foreign exchange risk, and explains why FASB 133 is one of the most complex FASB standards.

See Also This Related BrainMass Solution

Adopting Strategies to Minimize Foreign Exchange Risk

You are the chief financial officer (CFO) of a company that has recently entered the global marketplace. You have been meeting with the marketing and sales managers of the firm, and you are trying to adopt strategies that will minimize foreign exchange risk.

The sales and marketing managers are weighing the pros and cons of selling to customers in Mexico versus selling to customers in England. Because the sales and marketing managers are about to enter negotiations with large customers in both countries, you want to prepare them with important background information.

Part I

Complete the following requirements, and answer the following questions. Be sure to show all calculations:

1. Go to http://www.xe.com/ to determine the current exchange rate of U.S. dollars to Mexican pesos, and U.S. dollars to British pounds. Make sure to cite the source of data and the date on which you found it because exchange rates are always shifting.
2. Without hedging currency, answer the following questions:
2.1. What would happen to profits if you sold 1,000 widgets to each country (at today's exchange rate) at a price of either 1 pound each (if sold to England) or 25 pesos (if sold in Mexico)?
2.2. If the dollar weakened by 10% relative to each country's currency, what would be the new exchange rate used for this calculation?
3. What would happen to profits if you did hedging by buying forward contracts in foreign currency (at today's exchange rate) at a cost of $50, and after the purchase, the U.S. dollar depreciated by 10%?

Part II

From the exchange rate data determined, complete the following requirements:

1. Explain the pros and cons of hedging strategies
2. Explain what would have happened to profits or potential profits if the dollar had strengthened, rather than weakened (in Part I) and if the same forward contracts had been purchased for $50.
3. From the information obtained, give specific factors that you feel must be considered before buying futures contracts for currency.

Part III

Address the following questions and requirements:

1. How would you describe the political risks of doing business with a firm in England?
2. Would the political risks be different if you did business with a firm in Mexico? Explain your reasoning.
3. For each country, give at least 3 factors (good or bad) that must be considered before entering any business transactions with a firm from each respective country.

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