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Understanding the Cost of Hedging

Many companies take a backward approach to valuing derivatives hedges. Here’s how treasury teams should look at these costs instead.

By Amol Dhargalkar | October 13, 2021 at 11:11 AM

An accelerating economic recovery in the United States, along with uneven progress globally, is creating challenges for CFOs and treasurers in multinational organizations who are looking to more closely manage their companies’ financial risk.

Most large businesses spent the first half of this year evaluating their existing financial risk management programs in the face of increasingly volatile interest rate, currency, and commodity markets. Many responded to what they found by increasing their hedging activity. Treasury teams who are considering starting to use derivatives to hedge financial risks, or increasing their derivatives hedging activities, are often asked by board members or senior management “What’s the cost of hedging?”

In our work with more than 3,000 companies across the globe each year, we’ve usually seen the direct costs of hedging quantified in one of two ways: either by measuring transaction costs relative to market prices or by measuring whether each hedge made money or lost money. The first option is the best way to determine the true direct cost of hedging. It is also the most difficult.

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