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hedging

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › hedging

  • This topic has 1 reply, 2 voices, and was last updated 10 years ago by John Moffat.
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  • October 21, 2014 at 7:52 am #205196
    jess
    Member
    • Topics: 36
    • Replies: 19
    • ☆☆

    sir, can u explain how currency hedging can reduce a firm’s cost of capital?

    October 21, 2014 at 4:45 pm #205271
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54720
    • ☆☆☆☆☆

    Obviously I don’t know where you read this and therefore in what context it was written (for example, was it in the answer to a question where the company had long-term borrowing in a foreign currency?)

    In a more general sense however, if a company does a lot of trading in another currency (importing or exporting from/to another country) then they are at risk due to potential movements in exchange rates. It is one element of the risk within the business.
    If they hedge efficiently they will be able to eliminate (or at least reduce) this risk and therefore the business overall will become less risky.

    Since the return demanded by investors is dependent on the level of risk in the business, then reducing the risk will mean investors require a lower return and the cost of capital will therefore reduce.

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