Finance Essay Example | Topics and Well Written Essays - 2000 words - 7

Finance - Essay Example The global nature of business operations has given rise to foreign currency denominated transactions. This means that the companies have a significant amount of foreign currency receivables and payables in their financial statements. Therefore any adverse movement in the exchange rate can have a serious impact on the profitability position of the company. For this reason the companies hedge their position using financial derivative products like foreign currency options, forward contract, currency swaps, currency futures etc. The modernization of financial markets and the consequent development of advanced hedging techniques mean that the companies no more rely only on the traditional hedging methods rather now they employ various financial instruments to protect the value of their receivables. Many studies have been conducted about the foreign currency hedging practices of the companies. Academic literature relating to hedging has developed various theories that explain the incentives derived by an individual from hedging. Hedging protects the position of the hedger. Keynes states explicitly that the process of hedging eliminates risk (Ullrich, 2009, pp.107). In fact the financial derivatives can also be used for making speculative gains. This can be done by the companies who maintain a specialized risk management department as these professionals can take a position based on market anticipations. Various studies have been done to find as to why the firms hedge their overseas exposures. Some of these studies have focused on the usage of hedging tools like foreign currency derivatives and foreign currency debt (Judge, 2003). The strategy is chosen on the basis of the term of the exposure. For short-term exposures one expects that the firms will rely on derivatives. The long term exposure can be hedged using methods like issuance of debt and geographical asset diversification. A