Question

1. What is hedging? Explain how Volkswagen's failure to fully protect itself against foreign exchange fluctuations had a negative effect on the company? What can Volkswagen and other companies learn from this experience? 2. Why was Volkswagen so vulnerable to the change in the value of the Euro against the US Dollar relative to the US Dollar? 3. In 2015 and 2016 strong dollar affected several US companies. Please see the one of the examples in the following links (2015 and 2016) where the strong dollar hurt the company. What can this company do to protect itself from exchange rate fluctuations? Since the beginning of 2017, the dollar has been weakening. What does that mean for US companies? How will the weaker dollar affect US businesses?

Answer 1

Solution:

1) Hedging is a Position which is in the One Market in an Attempt to Offset exposure to change in the interest rate of an equal and opposite Obligation in the Other market.

Volkswagen hedged 70 percent of its foreign exchange exposure, but in 2003, the company was caught off guard by a sudden rise in the value of the euro against thedollar.Experts had failed to predict the rise in the euro, and Volkswagen, like other companiesthat failed to hedge their foreign exchange exposure, was hard hit.Volkswagen lost some €1.2billion as a result of its decision to hedge just 30 percent of its foreign exchange exposure.Moststudents will recognize that the experiences of Volkswagen underscores the volatility of theforeign exchange market and the need for companies to take steps to protect themselves even ifthere are no anticipated changes in currency values