The Portable MBA in Finance and Accounting, 3rd Edition

370 Planning and Forecasting

principally through its regular operating and financing activities.”^20 These
approaches to reducing currency exposure are usually referred to as natural
hedges. A number of examples of natural hedges were provided in Exhibit 12.2.
When natural hedges do not close out sufficient currency exposure, it is com-
mon for firms to turn to currency derivatives to reduce exposure still further.
Based upon the previous discussion of selected currency derivatives, the posi-
tions to be taken in the face of asset versus liability exposure are summarized
in Exhibit 12.9.
The information in Exhibit 12.9 indicates how a number of different in-
struments can be used to hedge currency risk. However, management must de-
cide whether, and to what extent, to hedge such risk. Some of the factors that
bear on the hedging decision are discussed next.

Inf luences on the Hedging Decision

The first hedging decision is whether or not to hedge currency exposure at all.
The decision of whether or not to hedge currency exposure is inf luenced, at
least in part, by the attitude of management towards the risk associated with
foreign-currency exposure. Other things equal, a highly risk-averse manage-
ment will be more inclined to hedge some or all currency-related risk. More-
over, not all currency exposure is seen to be equal. Firms have different
demands for hedging based upon whether the exposure has the potential to af-
fect cash f lows and earnings, or simply the balance sheet. Finally, the materi-
ality of currency exposure as well as expected movement in exchange rates will
also inf luence the demand for hedging.

Is Currency Exposure Material?

A common disclosure made by firms with currency exposure is the effect that a
10% change in exchange rates would have on results. For example, Titan Inter-
national, Inc. has currency exposure from its net investment in foreign sub-
sidiaries. Titan discloses the potential loss associated with an adverse movement
in the exchange rates of these subsidiaries:

The Company’s net investment in foreign subsidiaries translated into U.S. dol-

lars at December 31, 1999, is $55.4 million. The hypothetical potential loss in

EXHIBIT 12.9 Foreign currency exposure and hedging

decisions: Forwards, options, and futures.

Hedging Exposure

Instrument Asset Liability

For ward contract Sell foreign currency Buy foreign currency

Option Buy put options Buy call options

Futures Sell futures contract Buy futures contracts