Global Finance 363sake of simplicity, we are assuming that the spot value of the pound is equal to
the for ward rate at the inception of the for ward contract.^15
The gains and losses would be reversed if the U.S. firm in the above ex-
ample had a pound sterling accounting receivable. Moreover, the creation of a
hedge of this asset exposure in the pound sterling would call for the sale and
not the purchase of the pound sterling through the forward contract. Appreci-
ation of the pound sterling to $1.48 produces a transaction gain on the account
receivable for the U.S. firm. This would in turn be offset by a loss on the for-
ward contract. The value of the for ward contract declines when the spot value
of the pound sterling, $1.48, is greater than the rate to be received through the
for ward contract, $1.45.
Beckman Coulter Inc. provides a useful description of the offsetting gains
and losses created by hedges:
When we use foreign-currency contracts and the dollar strengthens against for-
eign currencies, the decline in the value of the future foreign-currency cash
f lows is partially offset by the recognition of gains in the value of the foreign-
currency contracts designated as hedges of the transactions. Conversely, when
the dollar weakens, the increase in the value of the future foreign-currency
cash f lows is reduced by...the recognition of any loss in the value of the for-
ward contracts designated as hedges of the transactions.^16Notice that Beckman Coulter talks of its future foreign-currency cash
f lows. This constitutes asset exposure to Beckman Coulter in the foreign cur-
rency. If the dollar strengthens, then it follows that the foreign currency de-
clines in value. The dollar value of the steam of foreign cash f low decreases.
Because Beckman Coulter is long the cash f low, it would hedge this exposure
by selling (taking a short position) the foreign currency through the for ward
contract.
Examples of Forward-Contract Hedging from Annual Repor ts A sampling of
firms that disclosed the use of for ward contracts, and the types of exposure
they are hedging, is provided in Exhibit 12.5. There are a substantial number of
different hedge targets in this small set of companies. They include:
- Inter-company loans.
- Cash f lows associated with anticipated transactions.
- Bonds payable.
- Accounts payable.
- Accounts receivable.
- Net investments in foreign subsidiaries.
- Expected acquisition transaction.
Over-the-counter currency options are a close second in popularity as a
hedging instrument and their nature and use are discussed next.