International_Trade

Introduction International trade acts an important role in the today’s human society. Firms have had to face such a problem which is how to avoid the risks caused by the fluctuations of exchange rate. Currency hedging can eliminate the FX risk. However, whether currency hedging adds firm market value, the academic question has dispute until now. In this essay, it is going to provides my arguments regarding the statement which is ‘currency hedging adds firm market value’, and prove it with academic research. After that, some strategies of managing the currency exposure will be discussed. Currency hedging adds firm market value Multinational companies often trade between countries. It takes time for exporters (importers) to receive (pay) money. Because the exchange rates are keep changing all the time. Multinational Corporations do not know the precise figures they are going to pay or receive. This variable situation is called uncertainty. Currency hedging usually eliminates the currency risk. Firstly, airlines always are sensitive to the exchange rate of currency which they use to buy the oil. In the airlines industry, because the fuel price is highly correlated to the investment opportunities, benefit of hedging with relation to oil price would be the reduction in underinvestment costs which company refusing to invest in the low-risk assets. Secondly, from the perspective of the Modigliani-Miller theorem, hedging does not change the value of the firm, if hedging merely reduces the idiosyncratic risk not to lower the firm’ taxes. However, in a progressive taxation system, hedging might reduce the expected payment of taxes, increasing firm's after-tax income. For example, the interest payment from money market hedging can reduce tax payment. Obviously, there is a positive impact on firm value. Thirdly, in the real world special risk within a firm can reduce its value. A company face bankruptcy will pay a great deal of money on lawyer, accountants, and ‘fire-selling’ assets. But if the company can avoid such situation by reducing the special risk of the cash flow, the company could get benefit from hedging. Firms can manage exchange risk by taking offsetting positions to reduce the uncertainty of future cash flows. From the perspective of accounting, a stable cash flow is the most important thing to the company, because it is about surviving. The more stable the cash flow the company has, the longer period of time the company might exist. Also there may be some benefits for the companies by reducing the volatility of their cash flow, the existence of costs of financial distress which is bankruptcy costs. Hedging would reduce the likelihood of paying these costs, which would add value to the firm. In January 2000, Air Products faced a strong fluctuation in the USD/GBP exchange rate in previous months. ‘We still fell we did the right thing in hedging the transaction. When you do Mergers and Acquisition you worry about having the economics of a deal change because of currency movements, and we are not in the business of making currency bets. People might think that a firm without international operation does not add value from currency hedging. Actually, there is a small and statistically insignificant hedging premium for companies no foreign involved. Even if GM only sells cars in US, it is still influenced by FX rate between JPY and USD. When JPY depreciates, Japanese car manufactories can get more market share with lower price. GM losses the market and the share price will go down. If shareholders invest in both Japanese car manufactures and GM, the fall in GM share price will be offset by the gain from Japanese car manufactures’ share price. The special risk can be eliminated by using the portfolio diversification. In summary, currency hedging both adds international operation companies and non-international operation companies’ market value more or less. Conclusion In conclusion, it is possible to improve the company’s market value when hedging reduced the tax or underinvestment costs of the company. Especially, when currency hedging reduces the likelihood of paying distress costs, firm market value adds. There are other strategies which can be used to hedging such as currency option, leading and lagging. The problem about how to select the appropriate strategy to manage risk depends on the level of awareness of the company. A rational strategy is according to the company’s market share, company’s structure, cash flow and the degree of specialization on foreign exchange market. In my opinion, there is no universal strategy, only the strategy which is most suited to the realities of the company.