Foreign Exchange Hedging

Hedging is one of the various ways that major economies can employ to cope up with a financial loss that may take place. There are a couple of reasons why it is important to hedge foreign exchange. The first reason has something to do with the instability of the economy. The condition of a country’s foreign exchange is dependent upon the social or political condition that exists in the country. For instance, if the current condition in the state sees turmoil, lawlessness, violence, and others, the foreign exchange rate can be high.

On the other hand, if the situation is normal, the economy would be stable and the foreign exchange rate would likewise be normal (Cherin ; Salahizadeh, 1988). The second reason for hedging is because of the volatility of the foreign exchange rates. Since 1974, most economies have adopted a “managed floating” system to combat the extremely volatile nature of foreign exchange (Cherin ; Salahizadeh, 1988). Tools For Hedging Foreign Exchange In order to alleviate possible foreign exchange risks, there are various tools used by countries in protecting their economies from losing financially.

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We shall be delving on at least a couple of them. The first method of hedging is borrowing and lending. This tool is used in order to take advantage of an increase or decrease in the foreign exchange rate. This is resorted to by a state to be able to compensate for any exposure in the current assets and liabilities as well as in projected income and expenditures (Cherin ; Salehizadeh, 1988). Another hedging tool is currency option.

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Here the two countries sign a customized or standard agreement which gives them the privilege to purchase or sell a certain currency value during a fixed period time.

The agreed price should be settled. The benefit of this hedging method is that it can minimize possible downside while maintaining any likely advantage (Cherin ; Salehizadeh, 1988). Global or Multinational? A firm’s decision to go global or multinational is not dependent on a single factor alone but on a mixture of various elements. For example, new and future environmental circumstances will make global strategy more possible than multinational. There are two factors that may have an impact on environmental changes. First is the commonness of products which the citizens in different countries want to purchase.

For instance, in any country in the world, people have the common interest of buying a mobile phone. Another factor that may affect environmental changes is the decrease in tariff and non-tariff barriers (Iman, 2005).

How to Become Globally Competitive?

For firms who want to expand their business on a global scope, there are five major dimensions which they can explore:

  • Being a Player in Major Markets States that have a considerable share in the global market that can initiate technology or consumer innovations can take advantage of the benefits of being a major player in the market (Yip, Loewe, &, Yoshino, 1988).
  • Core Product Standardization Multinational firms should be able to make their products cater to the needs of the local customers. The benefit of this approach is that it can make them close to their potential clients. A firm that has succeeded in this method is McDonald’s. People from Europe and Japan may think that they are eating American hamburger but in truth they are eating hamburger made to suit their taste (Yip, Loewe, ;, Yoshino, 1988).
  • Focusing Expansion in Few Countries. Instead of expanding your products to every nation, concentrate on certain countries only. By doing this, one can take advantage of the benefits that can be gained from that particular country (Yip, Loewe, ;, Yoshino, 1988).
  • Uniformity of Positioning and Marketing Mix By adopting uniformity of approach, one can take advantage of introducing strategies and programs to as many countries as possible. Focusing on promoting a single brand can give a firm a decided advantage compared to companies that push several products in different countries. The most successful companies using this kind of approach are McDonald’s, Coca-Cola, and Levis, to name a few (Yip, Loewe, &, Yoshino, 1988).

Countertrade as a Marketing Strategy

Countertrade is a two-way exchange of goods or services rather than monetary considerations. Twenty to twenty five percent of global trade are involved in countertrade. There are four main reasons for using countertrade. First, some countries do not have the ability to pay in the desired currency. This may be due to the absence or minimal foreign exchange (Iman, 2005). Another reason for countertrading is to generate new export channels. Third, countertrade serves as a means for protecting the sponsoring country. Finally, it is used to provide a distinct advantage over opposing suppliers (Iman, 2005). Determining When to Manufacture

The decision to manufacture depends on three important elements namely understanding of core and non-core segments, strict make versus buy evaluation, and implementation of manufacturing processes, whether to manufacture or purchase. In general, when the manufacturing firm can generate more savings than buying a product, then it is advisable to proceed with manufacturing rather than buying (Jones, et al. , 2001). Deciding When to Go In-House or Outsource According to Jones and his associates (2001) from Booz Allen & Hamilton, the following conditions are the circumstances that a manufacturing firm should stay in-house:

  • When the product pushed by the company is differentiated from the others
  • When the product is privately owned by the company
  • When the market is dominated by competitors
  • When the situation demands the company to “push the envelope”

On the other hand, the company can choose to outsource when:

  • Raw materials are not crucial to the finished product
  • Market is ideal for establishing close relations
  • Suppliers are open and has the capacity to accept innovations
  • Technology is stable (Jones, et al. , 2001) The decision whether to stay in-house or outsource can be facilitated by the application of best practices.

Implementing such will have a huge impact on the cost of the product. It has been discovered that companies who chose to stay in-house can still be in the thick of the competition after applying best practices (Jones, et al. , 2001).

Summary/Conclusion

There are various factors that may come into play and the management should be aware of them before coming up with a favorable decision. Specifically, the decision to go global or multinational, in-house or outsourcing, or buy or manufacture is vital to any marketing firm.

Firms like General Electric, IBM, among others, became successful because they carefully weighed the pros and cons of every decision. However, while outsourcing can be a good marketing tool and logical to do, it may not be the best alternative for the company. For instance, the company may not have the budget to undertake in an outsourcing venture. Thus, it is highly important for a company to carefully consider the benefits and drawbacks of every option before making a decision.

References

  1. Cherin, A. C. & Salehizadeh, M. (1988). Hedging strategies for foreign exchange risks. Journal of the Institute of Certified Financial Planners, 93-100.
  2. Iman, N. (2005, June 25). Understanding Global Strategy. Retrieved May 29, 2008 from http://nofieiman. com/repository/understanding-global-strategy. pdf
  3. Jones, F. , et al. (2001). Why Be In Manufacturing?. USA: Booz Allen & Hamilton, Inc. Retrieved May 29, 2008 from www. boozallen. com/media/file/60389. pdf
  4. Richardson W. T. (2005, July 11). Countertrade. Retrieved May 29, 2008 from http://www. witiger. com/internationalbusiness/countertrade. htm
  5. Yip, G. S. , Loewe, P. M. , & Yoshino, M. Y. (1988). How to take your company to the global market. Columbia Journal Of World Business, 23 (4), 37-48.

Cite this page

Foreign Exchange Hedging. (2020, Jun 02). Retrieved from https://studymoose.com/foreign-exchange-hedging-essay

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