Internal Foreign Exchange Hedging Techniques
The following figure makes a brief comparison of some of the internal foreign exchange techniques from the pros and cons aspects relative to others.
|
Techniques |
Description |
Pros |
Cons |
|
Borrowing and lending |
Creates a synthetic forward by borrowing and lending at home and abroad. For example, a long forward foreign-exchange position is equivalent to borrowing at home, converting the proceeds to foreign exchange and investing them abroad. The converse holds for a short forward foreign-exchange position. |
Useful when forwards, futures or swaps markets are thin-particularly for long-dated maturates. |
Utilises costly managerial resources. May be prohibited by legal restrictions. |
|
Commodity hedging |
Going short (long) a commodity contract denominated in a foreign currency to hedge a foreign currency to hedge a foreign exchange assets (liability). |
Commodity markets are usually deep, particularly for maturities up to a year. |
Price changes of commodities, in terms of home currency, may not exactly offset price changes in the asset (liability) to be hedged. |
|
Leading and lagging |
Equating foreign exchange assets and liabilities by speeding up or slowing down receivables or payables. |
Avoids unnecessary hedging costs. |
Appropriate matches may not be available. Utilises costly managerial resources. |
|
Matching |
Equating assets and liabilities denominated in each currency. |
Avoids unnecessary hedging costs. |
Appropriate matches may not be available. |
Source: Abuaf (1988)
If the company organises its international transactions within the company itself, it is called internal technique. It is also noted that internal techniques use methods of exposure management which are part of a firm’s regulatory financial management and do not resort to special contractual relationship outside the group of company itself.
These techniques aim to reduce or prevent exposed positions from arising. The main forms of internal techniques are netting, matching, pricing policies and asset liability management and leading and lagging.
