Should an MNC Risk Over hedging?
Point Yes. MNCs have some “unanticipated” transactions that occur without any advance notice. They should attempt to forecast the net cash flows in each currency due to unanticipated transactions based on the previous net cash flows for that currency in a previous period. 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 an MNC 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 in pesos by selling that amount of pesos forward or 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 MNC was able to hedge the minimum expected net cash flows.
Counter-Point No. MNCs 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 as a result of 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 MNC against exchange rate risk. It just changes the means by which the MNC is exposed.
Who Is Correct? Use the Internet to learn more about this issue. Offer your own opinion on this issue.