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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.
We shall be delving on at least a couple of them.
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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.
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).
For firms who want to expand their business on a global scope, there are five major dimensions which they can explore:
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:
On the other hand, the company can choose to outsource when:
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).
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.
Foreign Exchange Hedging. (2020, Jun 02). Retrieved from https://studymoose.com/foreign-exchange-hedging-essay
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