Explain THREE internal hedging methods that a company can use in order to minimise translation risk and transaction risk. (6 marks)
View Solution
- Translation risk is best managed by using matching. For example, in purchasing an asset in a foreign country, a company should raise the funds for the purchase in the foreign currency so both the asset and liability are in the same currency. There are a number of ways to hedge transaction risk internally. Matching, for example, could mean paying for imports in the same currency that a company invoices its exports in.
- Alternatively, a company could invoice customers in the domestic currency and find a supplier which does the same. The problem with this method, though, is that the company may lose foreign sales and also restrict the potential suppliers it can purchase from.
- Companies can also manage transaction risk by leading and lagging payments according to their expectations of exchange rate movements.