Finance Essay Sample with a Hedging Research

Most companies use hedging in managing their currency exposures. Hedging involves taking a position to acquire the cash flow of an asset or a contract that will fall or rise in value of an existing position (Shapiro, 2006). Hedging a specific currency exposure means developing an offsetting currency position to lock in a home currency thereby eliminating the risk caused by currency fluctuations. There are different types of hedging, internal hedging techniques (exposure netting, pre- payments, leading and lagging, long term structural changes, price adjustments) and external hedging techniques (forward and futures contracts, currency options, currency swaps) (Popov and Stutzmann, 2003). Internal hedging techniques involves all methods which, do not need any external parties while internal hedging techniques are methods that deal primarily with financial contracts like futures, swaps and forwards options. Hedging is essential in protecting a companys assets from losses. Based on financial theory, a firms value is the net present value of expected cash flows in future. If the cash flow currency is altered by the changes in exchange rates, a company hedging its currency exposures reduces the variance in its expected cash flows in future (Eiteman et al, 2007). Foreign exchange risk are therefore managed through internal and financial hedges (Mclaney, 2006). There is no different between speculation and hedging (Gandhi, 2006). Speculation means dealing in a financial asset or commodity to get profit on the prospective changes in the market value of goods being considered. It primarily involves contemplation of the expectations in future and taking positions in gaining. Hedging on the other hand involves taking offsetting positions and not with the aim of profiting. Speculation forecasts the evolution of demand and supply, for example exchange rates increases when speculators are long and reduces when they are short, and therefore they gain. But speculators lose when forecasts appear to be wrong. Therefore, hedging offsets risks by taking offsets positions, speculators are the individuals who bears the risk being transferred by hedgers. It is via this risk that they get reward in the form of speculative profits. Speculation and hedging are thus not the same and cannot be used interchangeably to get desired results or objectives. Hedging is a reducing technique or a risk management technique where the objectives is not earning profits, unlike speculation (Gandhi, 2006). Therefore, through hedging foreign exchange risk management is essential in eliminating the risks caused by currency variations (Shapiro, 2006). Glaum, (2000) describe that companies engaging in importing or exporting and multinational corporations have to hedge their exposed positions.

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The approach of the paper focus on the foreign exchange risk management practices employed by local import companies in Kenya, the foreign exchange risks hedged and the extent to which they are hedged and the foreign currency that contributes most to foreign exchange risk.

Methods

The population that was involved in the study included 24 companies as specified aggregate of study elements in Mombasa, engaging in import trading (Kenya Ports Authority, 2009). The size of the sample depended on the design of the research and sample size of 24 companies under survey. Data sources involved both primary and secondary data. Secondary data included source list from the Kenya Ports Authority containing company names in Mombasa County that are engaged in import trade. An updated list was not accessible and the sources left out were considered not to be different from the ones in the list on measured variables. Primary data was collected from the target respondents through interviews and observation and questionnaire. The questionnaire had three categories of questions; administrative questions, classification and target questions. The words in the questionnaire were simple and those that participants could answer. To discourage the participants from early discontinuation, the researcher structured the questionnaire to begin with the more interesting questions, moved from general to specific information and asked questions that were relevant to the respondents. In addition the researchers appreciated the effort and time taken by the participants by inclusion of a vote of thanks in the closure. The self- administered survey questionnaires was therefore critical in collecting data. The respondents were instrumental on the position of answering questions on risk management practices of their companies.