Should an MNE risk overhedging?
Point Yes. MNEs have some “unanticipated” transactions that occur without any advance notice. They should attempt to forecast the net cash flow on each currency due to unanticipated transactions. Even though it would be impossible to forecast the volume of these unanticipated transactions per day, it may be possible to forecast the volume on a monthly basis. For example, if a multinational company has net cash flows between 3 million and 4 million Philippine pesos every month, it may presume that it will receive at least 3 million pesos in each of the next few months unless conditions change. Thus, it can hedge a position of 3 million pesos by selling that amount of pesos forward of buying put options on that amount of pesos. Any amount of net cash flows beyond 3 million pesos will not be hedged, but at least the company was able to hedge the minimum expected net cash flows.
Counter-Point No. MNEs should not hedge unanticipated transactions. When they overhedge the expected net cash flows in a foreign currency, they are still exposed to exchange rate risk. If they sell more currency short from forward contracts than their net cash flows, they will be adversely affected by an increase in the value of the currency. Their initial reasons for hedging were to protect against the weakness of the currency, but the overhedging described here would cause a shift in their exposure. Overhedging does not insulate an MNE against exchange rate risk. It just changes the means by which the MNE is exposed.
Which one do you support? Give an example of an MNE hedging its FX risk and offer your own opinion on this issue. Only one citation for the MNE’s annual report is required.
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