Reasoning Behind Corporate Hedging
企业金融代写 Deviations from purchasing power parity are sufficiently large and persistent to expose companies to real exchange rate risk…
Deviations from purchasing power parity are sufficiently large and persistent to expose companies to real exchange rate risk and it is difficult to predict exchange rates
A zero-initial-value hedge can add value it interacts with the firm’s cash-flows in a positive way.
Financial Distress Costs 企业金融代写
Without bankruptcy costs, shareholders would simply lose control to bondholders. Insolvency would not impact the value. But really it incurs legal costs, disruption, lost clientele, and liquidation at much lower than going-concern prices.
The mere potential can impact operations and share value significantly. Financial structures are more complex, so restructuring is more costly.
Confidence in the firm’s ability to uphold an after-sales service or warranty
Risk-averse employees demand higher wages if their job prospects are uncertain. Losing valuable workers is not good for business.
Risk-averse suppliers may demand cash upon (/before) delivery making trade credit only possible with a default risk premium.
Loan covenants can trigger early repayment of a loan if income falls below a desired level or if there is a material deterioration in creditworthiness.
Increased risk spread and additional monitoring and reporting, and hassle and distraction or restriction on managers.
Homemade hedging does not provide the true advantage that corporate hedging does, and therefore does not perfectly act against the costs of distress
Agency Costs 企业金融代写
- Personal wealth may be linked to corporate performance. Personnel hedging is difficult and may leads to liquidity problems. Managers may refuse to undertake investment opportunities that are risky where the company does not hedge its exposures. Shareholders have imperfect information regarding opportunities and management incentives. Hedging makes the company more likely to take on these prospects and improves their position.
- Shareholders have a call option on the value of the firm, with the face value of the firm’s debt as the option’s strike price. The value increases when the volatility of the underlying asset increases. They have an incentive to invest in risky projects and conflict with bondholders in their fixed rate.
- Current value may go up when a project is undertaken but the option value (equity) goes down where the company has a debt overhang problem, causing shareholders to underinvest in positive NPV projects where the company has too much debt.
Expected Taxes
- Smoothing the income stream with a progressive tax schedule will reduce the average burden. It may be argued that most corporate tax schedules are flat, but the amount refunded with negative tax (losses) is limited to previous years, giving a certain amount of convexity with variability in income, which can be smoothed.
More Useful Information 企业金融代写
- A multinational knowing each division’s operating profitability without the noise introduced by unexpected exchange-rate changes. This can be achieved by each division hedging its cash flows, or compute contractual exposure (how profitable it would have been had it hedged), or it could use a reinvoicing centre.
- Without exchange rate noise, it’s easier to see the impact of management’s decisions. A hedging policy would reassure shareholders and analysts that their predictions and assumptions are closer to accuracy.
Reasons why Corporate Hedging is more Effective
- Firms can obtain better terms than the shareholders
- Shareholders have more imprecise knowledge regarding the firm’s exposure
- Personal borrowing in foreign currencies is difficult and forward positions require a substantial margin
Does Hedging Make the Invoicing Currency Irrelevant 企业金融代写
- Both buyer and seller can enter into a forward contract to lock-in their outflow or inflow. It doesn’t matter how the contract is set up (who is exposed) as they each have access to the same rates. This depends on them being able to do so at the same moment and rate.
- IF you list prices in foreign currency, you cannot hedge perfectly when there is a delay between the price announcement and the purchase decision, as the timing and volume is uncertain. The problem arises with substantial sales uncertainty and is less evident in the short-term horizon.
- The cost can vary depending on who hedges. A company that hedges total sales revenue will incur a lower total commission than its customers who hedge more frequent, lesser amounts.
Reason 3 – Unilateral Uncertainty (International Tenders)
- Alternatively, the buyer waits until all bids are submitted, translated them using prevailing forward rates, and notifies the winning supplier, locking in the best price using a standard forward contract.
- It’s costly when contenders are forced to submit bids in the buyer’s home currency. Conditional hedges charge more commission as the bank must assess the risk that a contender makes a losing bid. There’s also reverse risk, where the supplier is locked into an uncovered forward position, and must buy spot (or forward) to settle it – which is speculation.
Does Hedging Have a Cost 企业金融代写
- The ex-post value is just good or bad luck and is useless for decision making. Any initial value stems from positive interactions – the hedge itself having zero-NPV.
- Booking a forward premium as a genuine cost or gain (relative to the spot) doesn’t make sense. Booking a cost only makes sense where a commission is being paid, and forward contracts are usually free.
Doesn’t Spot Hedging Affect the Interest Tax Shield ?
- Borrowing in a high interest currency to hedge an outstanding cash inflow overlooks capital gains tax on exchange rate depreciations. The tax shield is only affects where gains are taxed differently to interest. Otherwise firm value is unaffected by borrowing in a different currency.
Analysts appreciate predictability, and strategists prefer not to be distracted by side items not arising through their decisions. They may argue the decision not to hedge is equal in risk to speculation.
