Hedging the currency risk generated by a global business’s anticipated future cash flows can be a bewildering task. Uncertainties inherent in revenue and cost projections, as well as the complexity of the foreign exchange (FX) market and related derivatives, all may contribute to concerns about the efficacy of hedging activities. Yet a well-constructed cash flow hedging program is worth the investment of time and effort.
A corporation’s valuation is based on the size and stability of its future cash flows, so if it can reduce its earnings volatility, it will increase its valuation and access to capital.
Turning Forecasts into Effective Hedges
Adjusting for Time-Horizon Uncertainties
Once the team has an estimate of the upcoming period’s net monetary assets (NMA), they can purchase hedging contracts to effectively offset the currency risks. If the team ensures that all their cash flow and balance sheet hedges expire on the same day each period, they can easily re-designate maturing cash flow hedges into the current period’s balance sheet hedges. Thus, the upcoming period’s NMA will always be hedged with a combination of maturing balance sheet contracts and maturing cash flow contracts.