Question

1. Corporations are using options and other derivative securities to hedge much more frequently than they have done in the past. What are the effects on the variability in the firm’s earnings?

2. Comment on the hedging vs. speculating uses of derivatives. Which is better?

Answer 1

1.Global trades are increasing day by day and it is encouraging the foreign currency transactions of companies. To mitigate the financial risk due to currency exchange rate fluctuation, companies are using options and other derivative securities much more frequently than they have done in the past.

The gain or loss of the company due to hedging using derivatives should be added to the net income or earning of the company for a particular time period.

2.Hedging is comparatively better than Speculating.

The amount of risk is very high in Speculating. Though, one can gain a lot from speculating by guessing the direction of asset movement but there is chance of loss also.

On the other hand, hedging is a financial risk management technique. In hedging, one has to take the opposite position (buy/sell) in derivatives of the position which he/she has taken for the underlying asset.