Mitigating Business Risks
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What are the appropriate techniques for mitigating risks in business?
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Solution Summary
This solution provides detailed explanations regarding techniques for mitigating risks in business.
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Action Plan to deal with risk
Firms have three available methods for managing their translation exposure: (1) adjusting fund flows, (2) entering into forward contracts, and (3) exposure netting.
Adjusting the fund flows
Essentially, the strategy involves increasing hard currency (likely to appreciate) assets and decreasing soft currency (likely to depreciate) assets, while simultaneously decreasing hard currency liabilities and increasing soft currency liabilities.
For example, if devaluation appears likely, the basic hedging strategy will be executed as follows: Reduce the level of cash, tighten credit terms to decrease accounts receivable, increase LC borrowing, delay accounts payable, and sell the weak currency forward. An expected currency appreciation would trigger the opposite tactics.
Forward contracts can reduce a firm's translation exposure by creating an offsetting asset or liability in the foreign currency.
Exposure netting is an additional exchange-management technique that is available to multinational firms with positions in more than one foreign currency or with offsetting positions in the same currency. As defined earlier, this technique involves offsetting exposures in one currency with exposures in the same or another currency such that gains and losses on the two currency positions will offset each other. ...
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