Hedging and Risk Management 4
Hedgingand Risk Management
Hedgingis a risk management procedure aimed at limiting the likelihood ofloss from fluctuations in the prices of commodities, currencies, orsecurities. Hedging is a transfer of risk without purchasing aninsurance policy. Considering the losses experienced by GM in Japan,the company should hedge before entering Russia (Lessambo, 2013).
Hedgingbefore entering Russia will ensure the continued flow of cash for GM.Price instability has an unfriendly impact on the income streams andcan upset money streams. Hedging protects organizations from suchunpredictable value developments, and guarantees continuous andstable income streams.
Accordingto Lessambo (2013), Hedging can encourage capital investment in thenew market. By locking input costs, GM will have the capacity tosecure itself against the rising operating expenses, and hence, makessolid arrangements for capital development and extension.
ConsideringRussia is a new market for GM, hedging will lower its taxliabilities. This is the most visible strategic reason for hedgingamong large firms, the immediate impact tax liabilities on firms.Russia is a new market with a completely new taxation system(Lessambo, 2013).
Hedgingbefore entering Russia will ensure good governance in the company(Lessambo, 2013). In case of a disagreement between the GM managersand the shareholder, on risk management policies, hedging permits away out of this dichotomy. By driving a wedge between risks that areexternal to the firm from those that are internal and afterwardbuilding a well thoroughly considered out Risk Management Policy thatlooks to exchange avoidable dangers out of the firm in astraightforward way, hedging can outline between the two sorts ofrisks. Hedging will also enable GM investors to segregate betweenlegitimate and reckless risk-taking, management behavior in the newmarket.
Conclusively,GM should hedge before entering Russia for this will put the companyin a better position to compete reducing risks and challenges in anew market. Hedging will also enable the company to avert losses ithas experienced in the other market such as Japan.
FXrisk is the risk of investment worth changing because of changes incash trade rates. There are different ways of hedging FX risk. Acurrency swap is one such method and it involves parties. Theinvolved parties agree to swap the equal amount of money (called theprincipal) and the interest rates over a fixed period (Lessambo,2013). The principal is usually a loan or a credit to one of theinvolved parties. Interest rates are swapped at one-year intervals,and this is where involved parties transfer, cash that assists themto hedge against fluctuation in the own currencies
Anothermethod of hedging FX risk is by purchasing currency option. Thisoffer the purchaser the option of buying or selling a foreigncurrency contract at a given price and date
Purchaseof gold is another method popular among large companies (Lessambo,2013). Gold and other valuable metals have been an investor hedgetool for ages. You simply buy gold and keep it since its price neverdrops it always on the rise therefore, you will never lose you moneyand might make profits in the future.
Exchangeof native currency for foreign currency is another way of hedging FXrisk (Lessambo, 2013). If you come from a country using dollars, onecan buy euros. If the value of the dollar drops relatively, you havesheltered yourself since you own other currencies.
Lessambo,F. (2013). Theinternational banking system: Capital adequacy, core businesses andrisk management.Houndmills, Basingstoke, Hampshire: Palgrave Macmillan.