Risk reducing financial transactions
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(1) Why might a firm undertake risk-reducing financial transactions, for example, a hedge against fluctuations in raw materials prices? Give at least one good reason. What types of risk-reducing financial transactions does your organization use?
(2) Which of the following companies would be more likely to hedge its raw materials prices? Explain your answer.
- A mature firm with no debt outstanding.
- A growth firm that will rely on debt to finance future capital investments.
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Why might a firm undertake risk-reducing financial transactions, for example, a hedge against fluctuations in raw materials prices? Give at least one good reason. What types of risk-reducing financial transactions does your organization use?
Firm having exposure in commodities, currencies and any other items require risk reducing transactions. This helps in:
1) Fixing the cash flows at a particular price. This helps the business to know about the future cash flows exactly.
2) It is necessary to manage risk at the individual transaction level, and to consider aggregate risk at the customer, industry, geography and collateral-type levels, where appropriate.
What types of risk-reducing financial transactions does your organization use?
Ours is an organization involved in foreign exchange. Risk is the uncertainty that you may not earn your expected return on your investments. For example, you may expect to earn 20% on your stock mutual fund every year. But your actual rate of return may be much lower. Multinational firms must constantly assess the business environments of the countries they are already operating in as well as the ones they are considering investing in. One of the most important international risks, which an organization faces, is exchange rate risk.
Exchange Rate Risk
Organizations which invest internationally in today's increasingly global investment arena face the prospect of uncertainty in the returns after they convert the foreign ...
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