Question

A usual textbook prescription for transaction exposure management is to hedge 100% of the notional value....

  1. A usual textbook prescription for transaction exposure management is to hedge 100% of the notional value. Yet some firms stay unhedged fully or partially. Discuss two (2) reasons why they may want to do so.
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Answer #1

Transaction exposure is the exposure related to the currency exchange rate. The businesses which are involved in the international trade may experience the currency exchange rate fluctuations. Exchange rate risk exposure is uncertain and must be hedged for the major capital losses.

Transaction exposure must be fully hedge, but some firms stay unhedged fully or partially due to the following reasons:

  1. Many firms are diversified in nature. It can be product diversification or market diversification. Thus, they don't feel to hedge the exchange rate risk as the loss in one product line can be substituted by the gain in others.
  2. Secondly, firms may feel that shareholders may themselves involve in hedging activity and can diversify their exchange risk.
  3. Firms may have self insurance protecting the exchange risk.
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