Solution for Hedging Foreign Exchange Risk - Case Study Example

Managing Foreign Exchange Risk; Role in Firm Value Creation Introduction With increasing number of finance organizations which are reliant on commercial foundations of the funding development, the subject of Foreign Exchange Risk is becoming an eminent aspect of concern for both the investors and the organizations. The stakes involved with investments as posed by the currency vacillations have escorted many finance investment mediums to loan mostly in dollars and Euros (Young et al, 2008). Whilst this run through of escorting in crucial currency defends the investors, it budges the Foreign Exchange stakes to the finance organizations that implement the hard currency liabilities to fund the portfolios of the loans denominated in its domestic currency (Young et al, 2008). This sort of currency disparity amongst the loans of the financial organizations and the assets by which the organizations are funded result in a huge risk where, if at all, the local currency of the nation in which the organization functions reduces against the U.S. Dollar, then the finance organization will be burdened with a substantially huge obligation of liabilities. This paper delineates the efficacious management of Foreign Exchange Risks with regards to hedging. Moreover, we would be able to seek a practical and a prolonging solution to it by applying an affiliation between the private sector and the benevolent communes to quintessentially conquer a chief hurdle which presently holds back the private sector from facilitating risk management assistances to the financial organizations. Moreover, with efficacious influence of the know-how along with the resources of the private sector as well as the economic resources of the benevolent commune, such kind of partnership across sectors possesses the calibre of elimination of the key cause of risk to foreign exchange management. Malawi and Zambia In order to analyze the consequences of hedging maize food security imports in the Malawi and Zambia on the South African Exchange or SAFEX, let us use a replicated approach. For many years, the South African Development Community has been subjected to poor grain harvests, when the government of both the countries tended to import grains at high prices. Concurrently, the foreign exchange of South Africa witnessed a gradual increment in the trading values of its cereals raising a positive flag for the likelihood of hedging regional import prerequisites (Dana et al, 2006). The hedging of imports can easily be accomplished by means of future contracts and associated financial options. The buying of elongated positions resolves the consequent SAFEX amount basis which construes to the fact that hedging, by bringing into use these instruments alone in unable to defend against the transformations in transport costs and economic costs for the reason that all of them may tend to vacillate widely. This results in a significant element of risk. As a result, the hedging schemes and replication results delineate that hedging by means of various futures or options may appear to increase the import costs with time passing by, which results in reduced inconsistency and likely producing lower standard prices. These advantages augment only if hedging is brought into implementation when domestic prices are at less than the import equivalence and also, if at all the hedge is powered. Nevertheless, there are chances for problems to stay as intra-regional transport prices stay elevated (Dana et al, 2006). A Case Analysis of a Swiss Organizational Share-holder The advisers associated with capital allocations generally make use of the mean-variance concept to illustrate the advantages of investing in hedge funds for the reason that it is verified that this is not most favourable when the capital is not ordinarily disseminated and establish an approach based on a customized "Value at risk" for the non-ordinarily disseminated assets or funds (Favre and Galeano, 2001). In order to comprehend in a trouble-free manner, we can study the instance of a Swiss pension fund share-holding part of its wealth in hedge funds, thereby, delineating that figuring a portfolio with mean and variance substantially results in underestimating the stakes of the portfolio. By means of a rigorous and vigilant analysis based on mean-variance optimization technologies, the special characteristics of hedge fund returns can be efficaciously taken into account. For the reason that, hedge fund returns are somewhat tilted, it is not possible to use the formula of Value at Risk, which is preferable for supposing a normal distribution. As a result, we can use the sample distribution of returns for hedge funds as an estimate for the dissemination of future returns. The method to examine the effects of the diversification of a Swiss pension fund collection by means of hedging funds effectively analyzes the fundamental presumptions of the study concept and models the risk in such a manner that can be easily construed to be steady with the characteristics of pension fund managers. Moreover, the analysis integrates the limitations which have been faced by the managers until now. With due assumption to the customized Value at Risk as a suitable gauge of risk for a Swiss pension fund, the results have illustrated that there are benefits to be observed and acquired from investing in the hedge fund asset class, as it can efficaciously be presumed that the portfolio of hedge fund asset is branched out appropriately, chiefly, all through the tremendous market down-turns (Favre and Galeano, 2001). CSFB/Tremont Hedge Fund Indices from 1994-2000 Many hedge funds assert to facilitate the considerable expansion for conventional portfolios, and hence, this case study analyzed the return as well as expansion benefits of hedge fund investments by means of CSFB/Tremont hedge fund indices from the year 1994 to 2000. It has been found that simple deteriorations of monthly hedge fund excess returns on monthly S&P 500 surplus returns appear to hold up the assertions (Asness et al, 2001). Nevertheless, this analysis seems to generate deceiving consequences as many hedge funds hold illiquid exchange-trading privacies which are often quite hard to price over the counter. As a result, for the sake of periodical reporting, hedge funds price these privacies with the use of any previously acceptable trading costs, or approximates of the prevailing market prices (Asness et al, 2001). Thus, with effectual implementation of standard techniques which account for such intricacy, it can be derived that hedge funds comprise of more market exposure than indicated by the simple approximates. Moreover, investors who construe their hedge funds as a guard from the market rectification should consider this as a critical matter of concern. The evidences from the study strongly propose that the pricing difficulties which are not harmonized can result in critically inconspicuous approximates of the hedge fund risk. Also, with limitations to analyze the indices, it may be somewhat likely to eradicate funds whose stake-attuned returns are overstated by the illiquidity. Nevertheless, it can hence be concluded that a cautious inspection of the claims made by the hedge funds are significant and such types of techniques should be employed by the investors whilst assessing hedge fund returns. Banorte Algo Market and Credit Integration Banorte has established itself as one of the largest organizations of Mexico with country-wide exposure (Case Study, 2003). However, it has faced many difficulties in managing a varied collection of portfolios which have been attained by means of mergers, along with the challenge of establishing a profitable business. In order to recognize as well as gauge the risks involved with the strategic planning, Banorte has applied an incorporated market and credit risk approach from Algorithmics which has provided it with a competitive advantage (Case Study, 2003). It makes use of the capital commerce for its hedging where the market constituent of the system arrives in to its own. This constituent aids the bank in making efficacious decisions on trades which allow it to hedge the stakes that it takes on the asset front. Moreover, it gauges the risks involved in these trades during the life cycle. This system has helped Banorte in recognizing every stake or risk, thereby, assigning a rectified price for every single loan credit. They are now competent enough to distinguish between the different business areas of their vicinity, thereby, recognizing the most profitable one. They grant credits in a highly unpredictable environment and, thus, the market risk application allows them to be certain about their margins on these credits and their prosperity over long tenure (Case Study, 2003). Conclusions With due consideration to the fact that most of the financial organizations are weakly capable of managing the Foreign Exchange stakes or risks, the finance commerce is presently hunting for ways to reduce the foreign exchange stakes which are innate to its international business. Nevertheless, a meticulous application appears to be capable producing an "indigenous hedge" by means of grouping the loans baptized in diversified up-and-coming market currencies. In order to attain the foreign exchange risk management, it is essential for the finance organizations to seek advantage from the risk management know-how of the financial sector. This will assist in reducing and eliminating the Foreign Exchange risk, thereby, lessening the disparity between revenues and debts, and facilitating supplementary constancy to their financial mock-ups. With efficacious leveraging of the know-how, the likelihood of eradication of a key cause of risk to financial institutions increases substantially. References 1. Asness, C. et al. 2001, Do Hedge Funds Hedge'. AQR Capital Management, LLC. 2. Case Study. 2003, Banorte Algo Market and Credit Integration Case Study. Algorithmics Incorporated. 3. Dana, J. et al. 2006, Hedging grain price risk in the SADC: Case studies of Malawi and Zambia. Food Policy 31 (2006), Elsevier: 357-371. 4. Favre, L. and Galeano, J. A. 2001, Portfolio Allocation with hedge Funds: Case Study of a Swiss Institutional Investor. Journal of financial transformation, The CAPCO Institute, 57-63. 5. Young, P et al. 2008, Solution for Hedging Foreign Exchange Risk in Microfinance Investments: The Case for a Private Sector-Philanthropic Community Partnership. IFC & Financial Times 2008 Silver Award Essay. Read More