Posted: July 5th, 2015
I need a response for the following discussions: I need 137 words each response.
1- by sam, Hedging is a policy in risk management that is employed by most firms to limit the possibility of occurrence of loss from the decrease in the prices of commodities securities and currencies. In other terms, hedging can be defined as the risk transfer without the act of buying policies from insurance.
If done well, the benefits of hedging can avoid financial distress by creating options to preserve value. However, if done poorly; hedging overwhelms the sense behind it. Hedging usually targets ostensible risks of businesses rather than the disposable economic revelation of a business which includes circuitous risks. These meandering risks are the highest for a company’s exposure to risk.
Institutions should only hedge what is important. They should only hedge against deals that pose a risk to their monetary health or threaten their strategic plans. Some companies use hedging plans that have little or no value to their shareholders. In order to determine the level of damage that a material risk can cause it’s important to have adequate cash flows. To determine whether the exposure to a given material risk, the company should first determine the companies’ cash flows are adequate for its cash. Companies should base their cash flow assessment on scenarios.
Institutions should look past hedges in finances. Managers should understand that an effective risk management program should include a combination of the financial hedges and non-financial hedges to alleviate risk but very few companies explore the two combinations which include commercial and operational; factors which reduces risk more efficiently and inexpensively. This includes- making decisions that pass the risks through a counter party, -strategic moves such as vertical integration operating changes for instance product specifications, shutting down the manufacturing facilities when the input cost peak or holding the additional cash reserves.
2-by Josh, I work for Lennox International, which has significant operations globally. The most significant currency exposures are to CAD, EUR, BRL and AUD. Exposure to CAD comes mainly from HVAC equipment manufactured in the US and sold in Canada. When CAD declines, the reduced USD revenue negatively impacts profits. Refrigeration equipment produced in China, is sold in Australia, exposing Lennox International to foreign exchange losses when the AUD declines. Equipment is both manufactured and sold in Brazil and Europe, which exposes Lennox to translational foreign exchange risks when profits are reported in USD.
Lennox International uses futures contracts to reduce the risk of future exchange rate changes. Most contracts are for 90 days or less, but there are also contracts as much as a year and a half ahead. One interesting observation is that even though Lennox has a small exposure to Russia, in 2014 Lennox had a hedge position worth hedge position worth $1.4 million on the RUB. This makes sense due to the high level of volatility and economic risk associated with business operations in Russia.
Lennox has manufacturing operations in Mexico, which could lead to losses if MXN appreciates, resulting in relatively higher cost of goods sold in the US. At the same time Lennox exports other equipment from the US to Mexico. In 2014 Lennox had futures contracts worth $14.6 million associated with these risks.
Even though there is much more economic exposure to Canada, Lennox did not have futures contracts for CAD. This could make sense due to lower currency volatility. Lennox has the financial strength to accept foreign exchange losses in some years in exchange for gains in others. Main competitors also manufacture in the US, subjecting them to the same currency pressures and giving more flexibility to raise prices in Canada if the CAD declines. However, if Lennox abruptly changes prices, but competitors are more gradual this could result in lost customers. Lennox could benefit from consistent use of CAD futures hedges for anticipated revenues from Canada. This would provide financial cover during gradual price changes.
Overall, the effect of currency translation adjustments is significant relative to the overall financial statements, but the effect of hedged has been minimal. Net income for 2014 was $205.8 million, with foreign currency translation adjustments of -$45.7 million, and reclassification of cash flow hedge losses into earnings of $5.7 million. It could make sense to Lennox to make greater use of currency futures to manage these risks.
Place an order in 3 easy steps. Takes less than 5 mins.