Strategies for Managing Foreign-exchange Risks

B. 

MNEs can devise a number of strategies to protect assets from exchange-rate risk. MNEs can hedge their position by adopting operational and/or financial strategies, each with cost/benefit and operational implications.

1. Operational Hedging Strategies. Firms may choose to balance local assets with local debt

by borrowing funds locally, because that helps avoid the foreign-exchange risk associated with

borrowing in a foreign currency. They may also choose to take advantage of leads and lags for

interfirm payments. A lead strategy means collecting foreign-currency receivables before they

are due when the currency is expected to weaken, or paying foreign-currency payables before

they are due when a currency is expected to strengthen. A lag strategy means delaying

collection of foreign-currency receivables if the currency is expected to strengthen, or delaying

payment of foreign-currency payables when the currency is expected to weaken.

2. Using Derivatives to Hedge Foreign-Exchange Risk. An MNE can also hedge exposure

through forward contracts and options, which establish fixed exchange rates for future

transactions and currency options, i.e., derivatives, which assure access to a foreign currency at

a fixed exchange rate for a specific period of time. A foreign-currency option is more flexible

than a forward contract because it gives the purchaser the right, but does not impose the

obligation, to buy or sell a certain amount of foreign currency at a set exchange rate within a

specified amount of time.