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Why firms hedge

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A) Should a firm hedge? Why or why not?

b) Recent surveys of corporate exchange risk management practices indicate that many US firms do not hedge. How would you explain this result?

c) GM exports cars to Spain, but the historically strong dollar against the Euro hurt sales of GM cars in Spain. In the Spanish market, GM faces competition from the German, Italian and French car makers. What kind of measures would you recommend so that GM can maintain its market share in Spain?

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Solution Summary

The solution explains why firms should hedge their risks, why some firms do not hedge and what steps a firm can take to maintain market share when faced with foreign exchange risk

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a) Should a firm hedge? Why or why not?

Hedging reduces the risk that a firm faces. The purpose of hedging is to make the outcome more certain. Thus a firm which has a foreign currency liability such as foreign loan repayment in 3 months would like to know before hand how much home currency would be required to purchase the foreign currency for making the payment. This is because if there is an adverse foreign exchange movement and if the firm has not hedged then it would incur losses. On the contrary side if there is a favorable foreign exchange movement then the firm if it has not hedged would make a profit. By not hedging, the exchange risk exposes a firm to uncertainty it may not be competent to handle and lead to losses which could be potentially damaging for its competitiveness.

The purpose behind hedging ...

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