Dozier

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International Financial Markets

Chapter 6

Why hedge exposure to exchange rates

Fall 1999

Raman Uppal

6-2

International Finance: Chapter 6 – Why hedge

Fall 1999

Road Map
1 Part A Part B 6 7 8 9 Part C Part D Part E Preliminaries: Conventions, notation, and basic concepts Currency markets and the behavior of the exchange rate Markets for exchange-rate derivatives and the hedging decision Why hedge exposure to exchange rates Measuring and managing exposure to exchange rates The market for currency futures The market for currency options Markets for fixed income securities and the financing decision Markets for equities and the portfolio investment decision Foreign direct investment

Fall 1999

International Finance: Chapter 6 – Why hedge

6-3

Contents
6.1 Main issues . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.2 Motivating problems . . . . . . . . . . . . . . . . . . . . . . 6.3 Implications of empirical evidence on exchange rate behavior . 6.4 When is value of a firm independent of its hedging policy
6.5.1 6.5.2 6.5.3 6.5.4 6.5.5

4 5 6 7 9
10 15 17 22 23

. .

6.5 How can hedging increase the value of a firm . . . . . . . . .
Corporate hedging reduces costs of financial distress . . . . . . . . “Home-made” hedging is not an efficient substitute for corporate hedging . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Hedging reduces agency costs . . . . . . . . . . . . . . . . . . . Hedging reduces expected taxes . . . . . . . . . . . . . . . . . . . Hedging may provide better information for internal decision-making

6.6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.7 Recommended readings 6.8 Practice problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

24 25 25

6-4

International Finance: Chapter 6 – Why…...

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